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The Optimal Response to Default: Renegotiation or Extended Maturity?

Thomas Miceli () and C. F. Sirmans
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C. F. Sirmans: University of Connecticut

No 2007-11, Working papers from University of Connecticut, Department of Economics

Abstract: This paper reinforces the argument of Harding and Sirmans (2002) that the observed preference of lenders for extended maturity rather than renegotiation of the principle in the case of loan default is due to the superior incentive properties of the former. Specifically, borrowers have a greater incentive to avoid default under extended maturity because it reduces the likelihood that they will be able to escape paying off the full loan balance. Thus, although extended maturity leaves open the possibility of foreclosure, it will be preferred to renegotiation as long as the dead weight loss from foreclosure is not too large.

Keywords: Agency costs; default; extended maturity; renegotiation; moral hazard (search for similar items in EconPapers)
JEL-codes: D82 G33 (search for similar items in EconPapers)
Date: 2007-05
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