Debt overhang and lack of lender’s commitment

Keiichiro Kobayashi, Tomoyuki Nakajima and Shuhei Takahashi

No 21-010E, CIGS Working Paper Series from The Canon Institute for Global Studies

Abstract: The debt overhang of sovereigns or firms is modeled in the recent literature as a constrained efficient outcome of dynamic debt contracts under the lack of the bor-rowers commitment, where debt relief is not Pareto improving. The early literature observes another type of debt overhang where the borrower is discouraged from ex-pending effort, anticipating that the lender will take all output ex post. We show that this inefficiency is due to the lack of the lenders commitment and that debt relief is Pareto improving. Nevertheless, debt overhang may persist, as frictional bargaining over debt relief can take a long time. Key words: Backloading, debt Laffer curve, two-sided lack of commitment.

Pages: 35
Date: 2021-08
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