Debt Overhang and Lack of Lender's Commitment

The debt overhang of sovereigns or firms is modeled in the recent literature as a constrained efficient outcome of dynamic debt contracts under the lack of the borrower's commitment, where debt relief is not Pareto‐improving. The early literature observes another type of debt overhang where the...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2023-12, Vol.55 (8), p.2153-2185
Main Authors: KOBAYASHI, KEIICHIRO, NAKAJIMA, TOMOYUKI, TAKAHASHI, SHUHEI
Format: Article
Language:English
Subjects:
backloading
Commitment
Debt cancellation
debt Laffer curve
two‐sided lack of commitment
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Summary:The debt overhang of sovereigns or firms is modeled in the recent literature as a constrained efficient outcome of dynamic debt contracts under the lack of the borrower's commitment, where debt relief is not Pareto‐improving. The early literature observes another type of debt overhang where the borrower is discouraged from expending effort, anticipating the lender to take all output ex post. We show that this inefficiency is due to the lack of the lender's commitment and debt relief is Pareto‐improving. Nevertheless, debt overhang may persist, as frictional bargaining over debt relief can take a long time.
ISSN:0022-2879
1538-4616
DOI:10.1111/jmcb.12969