Abstract
We consider a financing game where monitoring is costly, non-contractible and allowed to be stochastic. The optimal contract, which is debt, induces creditor leniency and strategic defaults on the equilibrium path, consistent with empirical evidence on repayment and monitoring behavior in credit markets. Our paper is the first where the optimal contract is debt and default is not synonymous with bankruptcy.
| Original language | English |
|---|---|
| Pages (from-to) | 149-165 |
| Number of pages | 17 |
| Journal | Economic Theory |
| Volume | 44 |
| Issue number | 1 |
| Early online date | 23 Apr 2009 |
| DOIs | |
| Publication status | Published - Jul 2010 |
Keywords
- costly state verification
- debt contract
- priority violation
- strategic defaults