Optimal contracts under imperfect enforcement revisited

Hans Hvide

No 2005/4, Discussion Papers from Norwegian School of Economics, Department of Business and Management Science

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 (search for similar items in EconPapers)
JEL-codes: D02 D82 G21 G33 (search for similar items in EconPapers)
Pages: 21 pages
Date: 2005-09-12
New Economics Papers: this item is included in nep-fin and nep-fmk
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