A Theory of Debt Based on the Inalienability of Human Capital.

Consider an entrepreneur who needs to raise funds from an investor but cannot commit not to withdraw his human capital from the project. The possibility of a default or quit puts an upper bound on the total future indebtedness from the entrepreneur to the investor at any date. The authors characterize the optimal repayment path and show how it is affected both by the maturity structure of the project return stream and by the durability and specificity of project assets. The authors' results are consistent with the conventional wisdom about what determines the maturity structure of long-term debt contracts. Copyright 1994, the President and Fellows of Harvard College and the Massachusetts Institute of Technology.