Working Paper: CEPR ID: DP2037
Authors: Gilles Chemla; Antoine Faure-Grimaud
Abstract: In many long-term relationships, parties may be reluctant to reveal their private information in order to benefit from their informational advantage in the future. We point out that the strategic use of debt by an uninformed party induces another party to reveal private information. Our argument, which is consistent with casual observation, is based on the idea that (renegotiable) debt is a credible commitment to end the long-term relationship if information is not revealed. We show that the strategic advantage of debt increases with good durability and we briefly address the financing decision of a regulated firm.
Keywords: dynamic adverse selection; durable good; ratchet effect; renegotiation; financial constraint; debt
JEL Codes: D42; D82; G32; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic use of debt (G32) | induce buyer to reveal private information (D82) |
| not revealing information (D82) | facing cash constraints (F35) |
| not revealing information (D82) | inefficient debt renegotiation (F34) |
| inefficient debt renegotiation (F34) | partial liquidation of assets (G33) |
| debt creates situation (F34) | expected rents from withholding information are lower (D89) |
| expected rents from withholding information are lower (D89) | utility from revealing information is higher (D89) |
| utility from revealing information is higher (D89) | incentivizes buyer to disclose true valuation (G24) |