Debt and Wage Negotiations: A Bankruptcy-Based Approach.

The role of debt in wage negotiations is considered in a framework where both the entrepreneur and the workforce are indispensable in production. When workers and the entrepreneur fail to reach an agreement, the firm eventually defaults. Bankruptcy is represented as a three-party bargaining game among the entrepreneur, workers, and lenders. The author shows that debt financing, by reducing workers' bargaining power, increases the firm's share of surplus and improves the incentives to invest. Further, his model allows for overborrowing (the firm borrows more than required by its productive activity) as well as underinvestment due to wealth constraints. Copyright 1996 by The editors of the Scandinavian Journal of Economics.