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Optimal Debt Contracts with Renegotiation

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  • Murat Usman

Abstract

This paper sutudies the role of debt in committing a seller not to trade at a low price. We consider a discrete‐time finite‐horizon buyer–seller relationship. The seller makes an upfront relationship‐specific investment, which is financed with debt. Debt then is repaid gradually to mitigate the hold‐up risk. Even though debt is renegotiable, under the assumption that with a small probability renegotiation may fail and may lead to inefficient liquidation, debt still can be used as a commitment device. We solve for renegotiation proof dynamic debt contracts that are optimal for the seller and show that debt is repaid over the entire course of the relationship with declining repayments.

Suggested Citation

  • Murat Usman, 2004. "Optimal Debt Contracts with Renegotiation," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(4), pages 755-776, December.
    • Handle: RePEc:bla:jemstr:v:13:y:2004:i:4:p:755-776
    DOI: 10.1111/j.1430-9134.2004.00031.x
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    References listed on IDEAS

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    Cited by:

    1. David Card & Francesco Devicienti & Agata Maida, 2014. "Rent-sharing, Holdup, and Wages: Evidence from Matched Panel Data," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 81(1), pages 84-111.
    2. Usman, Murat, 2008. "Commitment with renegotiable debt contracts and verifiable cash flow," Economics Letters, Elsevier, vol. 99(2), pages 249-251, May.

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