Renegotiation of Debt Contract With Partially Informed Lender
Renegotiation is valuable in debt contract because it mitigates the dead-weight losses of bankruptcy. This dissertation investigates the importance of a verification technology used before the renegotiation stage. Using the verification technology is optimal when the dead-weight losses associated with liquidating insolvent borrowers is greater than the cost of the verification technology. We show that the advantage of renegotiation and the optimal renegotiation procedure does not depend on the lender's ability to commit or not to the terms of a contract. The renegotiation procedure, however, depends on the acquisition and quality of the signal about the borrower's capacity to pay. The optimal renegotiation procedure uses a menu of offers when the lender does not gather information. The use of an accurate verification technology induces the lender to propose a unique renegotiation offer according to the signal received. A less accurate technology induces the lender to propose one single offer when the signal indicates solvency and a menu when the signal indicates insolvency. An equilibrium in which successful borrowers do not default is attainable when renegotiation is pursued with an accurate verification technology.
University of Illinois - Urbana-Champaign
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University of Illinois at Urbana-Champaign