Essays on financial contracting and debt

• Main Author: Britto, Paulo Augusto Pettenuzzo de
• Format: Dissertation
• Language: English
• Subjects: economics, finance; economics, general; economics, theory

This thesis investigates some aspects of financial contracting and debt under two different institutional arrangements. The first chapter analyzes the case where the borrower is a wealth-constrained small firm not able to self-finance outright its investment project. The borrower-lender relationship is regulated by a legal system and a bankruptcy code, which establishes residual claim rights to the lender if the borrower defaults on its debt payments. However, these residual claims are subjected to costly court proceedings. The court generates two different incentives: first it gives bargaining power to the lender in case of default, and second it generates a dead-weight loss that induces an out-of-the-court renegotiation. This chapter's main results are: (i) if the court system is efficient-the court costs are sufficiently low-then the equilibrium will be unique and in mixed strategies; (ii) inefficient judicial system generates strategically default-default by a solvent borrower-debt forgiveness, and credit rationing; (iii) a harsher legal system induces less default by the borrowers and more debt forgiveness by the lenders; and (iv) a higher degree of debtor protection induces less default by the borrower, and less debt forgiveness by the lender. The second chapter explores a sovereign indebted country facing a choice of economic policy today that will determine the country's ability to continue its debt servicing in the future. If the sovereign undertakes an unsound economic policy it will repudiate its debt with certainty, otherwise it will repudiate its debt with some positive strictly less than one probability. In our framework there is no court to enforce contracts. However, the presence of multilateral financial institutions and the perspective of a debt bail out distort the incentives to economic choice. Also, the international financial markets may "punish" a defaulting sovereign by reducing its access to goods and capital markets. The main result of the essay is that the multilateral will bail out a defaulting country regardless of the economic choice undertaken in order to avoid bigger losses from more defaults generated by financial crisis contagion.