Affiliations: MIT, Harvard, and NBER (Froot); MIT and NBER (Scharfstein); Harvard and Council of Economic Advisers (Stein). We thank Geoff Carliner, Sue Collins, Martin Feldstein, Kala Krishna, Greg Mankiw, Kathy Mann, Ken Rogoff, and Jeff Sachs for helpful comments and Kathryn Dominguez for help in obtaining data. All errors remain our own.
LDC Debt: Forgiveness, Indexation, and Investment Incentives
Article first published online: 30 APR 2012
1989 The American Finance Association
The Journal of Finance
Volume 44, Issue 5, pages 1335–1350, December 1989
How to Cite
FROOT, K. A., SCHARFSTEIN, D. S. and STEIN, J. C. (1989), LDC Debt: Forgiveness, Indexation, and Investment Incentives. The Journal of Finance, 44: 1335–1350. doi: 10.1111/j.1540-6261.1989.tb02656.x
- Issue published online: 30 APR 2012
- Article first published online: 30 APR 2012
We compare different indexation schemes in terms of their ability to facilitate forgiveness and reduce the investment disincentives associated with the large LDC debt overhang. Indexing to an endogenous variable (e.g., a country's output) has a negative moral hazard effect on investment. This problem does not arise when payments are linked to an exogenous variable such as commodity prices. Nonetheless, indexing payments to output may be useful when debtors know more about their willingness to invest than lenders. We also reach new conclusions about the desirability of default penalties under asymmetric information.