Two Tales of Debt

Recent research suggests that corporate debt contracts in the modern economy follow two common approaches: Some contracts lend against the liquidation value of separable assets, while others focus on cash flows from operations and the going-concern value of the firm as a whole. This article summarizes the key contract features and default resolution mechanisms of these two types of debt used by nonfinancial firms. Firms with abundant liquidation values and physical assets rely on the former; firms with low liquidation values and limited physical assets resort to the latter. Among large firms and those with positive earnings, total borrowing does not depend on physical assets, whereas among small firms and those with negative earnings, total borrowing remains dependent on physical assets. The evidence sheds light on the evolving nature of debt contracting and financial intermediation, with implications for economic fluctuations and growth.