Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
Hans K. Hvide
Optimal contracts under imperfect enforcement revisited
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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