RECENT attempts to resolve the international debt crisis have led certain debtor countries to inaugurate debt-equity conversion programmes (henceforth swaps) in which external creditors are a party to the transaction.' This paper analyses one aspect of swaps which has received little attention so far, their impact on debtor country investment incentives. Much of the existing analysis of swap programmes proceeds under the assumption that swaps do not alter the expectations of parties with respect to the present value of expected resource transfers made to service the debt. By demonstrating that debt conversion schemes affect the incentives of debtor nations to exercise certain investment options, this essay relaxes that assumption. We analyse the implications of endogenizing debtor country investment behaviour for market expectations of the present value of debt service payments, the secondary market price of debt, and derive conditions under which swaps are mutually beneficial to swap programme participants. The development of the paper is easily summarized. Section 2 briefly reviews existing opinion regarding the benefits and costs of debt conversion schemes, and presents an overview of some recent debt-equity conversion programmes. The basic model for analysing swaps is developed in Section 3; it is based on the standard assumption that the debtors' real income is a random variable, and its foreign debt is government owned. Following Helpman (1989), we begin by characterizing a debt-equity swap as an exchange of debt for claims on the random output, and illustrate the transfer of resources from debtor to creditors arising from the introduction of such a programme. In a world of risk neutral participants, we show that creditors only gain as a result of the swap in states where debtors lose, and vice versa. In Section 4 we modify the Helpman framework to analyze the investment incentive effects of swaps. By subordinating the claims of equity holders to those of debt-holders, swaps are shown to increase the debtor nation's incentives to commit capital to projects commanding a positive net present value, thereby raising the expected level of debtor country output. Swaps have been praised for their risk-sharing features.2 However, by failing to consider their effect on investment incentives, swap's ability to generate efficiency gains resulting from