Private Renegotiations and Government Interventions in Debt Chains

Abstract

We propose a 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 its privately-informed borrower depends on how the lender's own liabilities are expected to be renegotiated. Our analysis reveals how government interventions that aim to prevent default waves should account for these private renegotiation incentives and their interlinkages. Our results shed light on the effectiveness of subsidies and debt reduction programs following economic shocks such as pandemics or financial crises

Keywords: Debt Renegotiation, Credit, Bargaining Power, Default Waves

JEL Classification: G21, G32, G33, G38