Productivity and Debt in Relational Contracts
This paper studies how financial obligations constrain incentives, which generates productivity dynamics. A liquidity-constrained manager simultaneously repays a creditor and motivates a worker. If the manager cannot commit to output-contingent payments, then effort increases as the manager repays debts in a profit-maximizing equilibrium. The manager might defer worker compensation while repaying the creditor, in which case effort depends on both current and past debts. If the manager and worker can collude, which the creditor deters by threatening liquidation, then debt again has a lingering effect on the relational contract. Empirically, current and past debt increases are correlated with productivity decreases.
Daniel Barron, Jin Li
Barron, Daniel, and Jin Li. 2018. Productivity and Debt in Relational Contracts.