ECGI New Working Paper Alert
ECGI Finance Series 780/2021
Tuesday 5 October 2021
When Is (Performance-Sensitive) Debt Optimal?
Pierre Chaigneau, Queen’s University Alex Edmans, London Business School, CEPR, Gresham College and ECGI Daniel Gottlieb, London School of Economics and Political Science
Existing theories of debt consider a single contractible performance measure ("output"). In reality, many other performance signals are also available. It may seem that debt is no longer optimal; for example, if the signals are sufficiently positive, the agent should receive a payment even if the output is low.
This paper shows that debt remains the optimal contract under additional signals -- they only affect the face value of debt, but not the form of the contract. We show how the face value should depend on other signals, providing a theory of performance-sensitive debt.
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