This paper shows how a firm might optimally choose debt to affect the
outcome of bilateral bargaining with workers or other input suppliers. It is
shown that debt may alleviate the well known underinvestment problem
associated with the inability to write precommitment contracts. Also, in such
circumstances, debt could be Pareto improving over complete equity financing.
The relationship between the optimal level of debt and asset specificity of
investment and bargaining power of the firm vis-a-vis the workers is explored.
The Williamson conjecture that higher asset specificity will lead to less debt is
shown not to be valid in general.