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Costly monitoring, dynamic incentives, and default

Gaetano Antinolfi () and Francesco Carli

Journal of Economic Theory, 2015, vol. 159, issue PA, 105-119

Abstract: We study dynamic contracts between a lender and a borrower in the presence of costly state verification and hidden effort. We prove three results. Costly monitoring is employed by the lender to optimally limit history dependence and prevent future inefficient termination of the relationship. Due to interaction between costly monitoring and dynamic incentives, the probability of monitoring may fail to be monotone in the borrower's reservation utility. Finally, following the interpretation of the costly state verification literature, we distinguish two levels of bankruptcy: one associated with restructuring and the other with liquidation.

Keywords: Costly state verification; Default; Monitoring; Dynamic contracts; Moral hazard (search for similar items in EconPapers)
JEL-codes: D86 C73 D80 (search for similar items in EconPapers)
Date: 2015
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Working Paper: Costly Monitoring, Dynamic Incentives, and Default (2012) Downloads
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DOI: 10.1016/j.jet.2015.05.011

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