Scandinavian Working Papers in Economics
Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science
No 2005/4: Optimal contracts under imperfect enforcement revisited
Hans K. Hvide ()
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Hans K. Hvide: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway
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
21 pages, September 12, 2005
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