DEBT-EQUITY SWAPS - INVESTMENT INCENTIVE EFFECTS AND SECONDARY MARKET PRICES

This paper analyses the investment incentives associated with a debt-equity swap programme. Swaps increase debtor nations' incentives to commit capital to investments with a positive net present value. A necessary condition for mutually beneficial swaps is derived which, unlike alternative models, is independent of the risk attitudes of swap market participants. Two results follow. First, debtors will swap a maximum proportion of equity in an investment project with foreign creditors. Second, creditors require a minimum price of equity in terms of debt to participate in the swap. The swap's effects on the secondary market price of debt are examined.