 The Role of Collateral in a Model of Debt RenegotiationCEPR Financial Markets Paper from European Science Foundation Network in Financial Markets, c/o C.E.P.R, 33 Great Sutton Street, London EC1V 0DX. Abstract: This paper studies the effect of debt renegotiation on the design of optimal loan arrangements in a model of borrowing and lending with asymmetric information. The optimal form of finance is a standard debt contract with a bankruptcy clause that acts as a payment incentive. Debt renegotiation may occur because bankruptcy involves costly asset liquidation which is ex post inefficient. We show that the extent of the entrepreneur's liabilities in the optimal loan contract depends upon the creditor's commitment to impose bankruptcy should default ever occur. If the creditor is precommitted not to forgive any portion of the outstanding debt, a limited liability arrangement is optimal. That is, default should entitle the creditor to liquidate only the assets remaining from the project that has been financed by the loan. In the absence of precommitment, however, the issuance of debt may efficiently be secured in addition by the entrepreneur's personal wealth outside the project. Keywords: Debt Contracts; Renegotiation; Secured Lending (search for similar items in EconPapers) There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it. Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprfm:0001 Ordering information: This working paper can be ordered from Access Statistics for this paper More papers in CEPR Financial Markets Paper from European Science Foundation Network in Financial Markets, c/o C.E.P.R, 33 Great Sutton Street, London EC1V 0DX. |
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