Private Renegotiations and Government Interventions in Credit Chains

Abstract

We propose a model of strategic renegotiation in which businesses are sequentially interconnected through their liabilities. This financing structure, which we refer to as a credit chain, gives rise to externalities, as each lender's willingness to provide concessions to its borrower depends on how this lender's own liabilities are expected to be renegotiated. We highlight how government interventions aimed at preventing default waves should account for private renegotiation incentives and their interlinkages. In particular, we contrast the consequences of targeted subsidy and debt reduction programs following economic shocks such as a pandemic or financial crisis.

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

JEL Classification: G21, G32, G33, G38