One-Sided Enforcement in a Model with Persistent Adverse Selection

David Martimort and Aggey Simons (Semenov)

No 26-1704, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: We study a repeated buyer-seller relationship with persistent adverse selection and one-sided enforcement, where a prepaid seller can breach by taking the money and running. The optimal stationary contract depends on enforcement strength and the discount factor. Three regimes arise. With a strong legal system, penalties deter breach and the optimal static contract can be repeated. With a weak system, the penalty caps transfers, forcing bunching among efficient (low-cost) types. With a very weak system, compliance relies on relational rents, causing large downward distortions. Strengthening public enforcement relaxes both incentive and enforcement constraints, reducing allocative inefficiency.

Keywords: Adverse selection; Limited enforcement; Relational contracts; Contract breach (search for similar items in EconPapers)
JEL-codes: D82 D86 K12 O17 (search for similar items in EconPapers)
Date: 2026-01-30
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Persistent link: https://EconPapers.repec.org/RePEc:tse:wpaper:131355

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