Working Paper: CEPR ID: DP16433
Authors: Alex Edmans; Pierre Chaigneau; Daniel Gottlieb
Abstract: Existing theories of debt consider a single contractible performance measure ("output"). In reality, many other performance signals are also available. It may seem that debt is no longer optimal; for example, if the signals are sufficiently positive, the agent should receive a payment even if output is low. This paper shows that debt remains the optimal contract under additional signals -- they only affect the face value of debt, but not the form of the contract. We show how the face value should depend on other signals, providing a theory of performance-sensitive debt.
Keywords: Informativeness principle; Limited liability; Performance-sensitive debt
JEL Codes: D86; G32; G34; J33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Positive performance signals (P17) | Adjustment in the face value of debt (G32) |
| Negative signals (D91) | Reduction in optimal payment under certain conditions (H21) |
| Likelihood ratio of output exceeding the face value (C29) | Optimal debt repayment (H63) |
| Performance signals (L25) | Face value of debt (G32) |