Dynamic Adverse Selection and Debt

Gilles Chemla () and Antoine Faure-Grimaud

No 2037, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In many long-term relationships, parties may be reluctant to reveal their private information in order to benefit from their informational advantage in the future. We point out that the strategic use of debt by an uninformed party induces another party to reveal private information. Our argument, which is consistent with casual observation, is based on the idea that (renegotiable) debt is a credible commitment to end the long-term relationship if information is not revealed. We show that the strategic advantage of debt increases with good durability and we briefly address the financing decision of a regulated firm.

Keywords: Debt; Durable Good; dynamic adverse selection; financial constraint; Ratchet Effect; Renegotiation (search for similar items in EconPapers)
JEL-codes: D42 D82 G32 L14 (search for similar items in EconPapers)
Date: 1998-12
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Working Paper: Dynamic Adverse Selection and Debt (1996)
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