Renegotiation in Debt Chains
We develop a tractable model of strategic debt renegotiation in which businesses are sequentially interconnected through their liabilities. This financing structure, which we refer to as a debt chain, gives rise to externalities as a lender’s willingness to provide concessions to his privately-informed borrower depends on how this lender’s own liabilities are expected to be renegotiated. Our analysis reveals how targeted government subsidies and debt reductions as well as incentives for early renegotiation following large economic shocks such as COVID-19 or a financial crisis can prevent default waves.
The authors thank Manuel Adelino, Simon Gervais, Stefano Giglio, Ron Kaniel, Stefan Nagel, Greg Nini, Michael Roberts, Amir Sufi, Mathieu Taschereau-Dumouchel, Xingtan Zhang, Hongda Zhong and seminar participants at the University of Notre Dame and the Wharton School for their helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.