Debt contracts with partial commitment

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Abstract

This paper analyzes a dynamic lending relationship where the borrower cannot be forced to make repayments, and the lender offers long-term contracts that are imperfectly enforced and repeatedly renegotiated. No commitment and full commitment by the lender are special cases of this model where the probability of enforcement equals zero and one, respectively. I show that an increase in the degree of enforcement can lower social welfare. Furthermore, properties of equilibrium investment dynamics with partial commitment drastically differ from those with full and no commitment. In particular, investment is positively related to cash flow, consistent with empirical findings.

Original languageEnglish (US)
Pages (from-to)2848-2874
Number of pages27
JournalAmerican Economic Review
Volume103
Issue number7
DOIs
StatePublished - Dec 1 2013

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ASJC Scopus subject areas

  • Economics and Econometrics

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