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The Role of Collateral in a Model of Debt Renegotiation

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  • Bester, H.

    (Tilburg University, School of Economics and Management)

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. Renegotiation may occur because bankruptcy involves costly asset liquidation, which is ex post inefficient. The author shows 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. A limited liability arrangement is optimal whenever the creditor is precommited not to forgive any portion of the outstanding debt. Otherwise debt may efficiently be secured by outside collateral. Copyright 1994 by Ohio State University Press.
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Suggested Citation

  • Bester, H., 1990. "The Role of Collateral in a Model of Debt Renegotiation," Other publications TiSEM c3595a51-2a58-40d7-9128-a, Tilburg University, School of Economics and Management.
    • Handle: RePEc:tiu:tiutis:c3595a51-2a58-40d7-9128-a892526f7e7c
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    References listed on IDEAS

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    1. Oliver Hart & John Moore, 1998. "Default and Renegotiation: A Dynamic Model of Debt," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 113(1), pages 1-41.
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