Long-Term Contracts, Short-Term Investment and Monitoring

Ernst-Ludwig von Thadden

The Review of Economic Studies, 1995, vol. 62, issue 4, 557-575

Abstract: The paper presents a dynamic contracting model of myopic firm behaviour caused by the fear of early project termination by outside investors. Although the parties can conclude longterm contracts, asymmetric information between investors and firms can make it impossible to implement profitable long-term projects. The paper characterizes the structure of optimal, renegotiation-proof contracts for unmonitored and monitored finance. Monitoring by investors, although itself subject to distorting incentive constraints, is shown to be able to overcome the short-term bias of investment and thus to lengthen the firms' planning horizon.

Date: 1995
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