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. We 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. Our results are consistent with the conventional wisdom about what determines the maturity structure of long-term debt contracts.