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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2005/4:
Optimal contracts under imperfect enforcement revisited

Hans K. Hvide ()

Abstract: We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behavior in credit markets.

Keywords: Costly state verification; debt contract; priority violation; strategic defaults; (follow links to similar papers)

JEL-Codes: D02; D82; G21; G33; (follow links to similar papers)

21 pages, September 12, 2005

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