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Self-enforcing stochastic monitoring and the separation of claims

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  • Cole, Harold L.
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    Abstract

    A model of self-enforcing stochastic monitoring with investment and production is developed. The optimal contract leads to debt-like and equity-like claims on the firm that are held by symmetrically informed outside investors and rationalizes the separation of these claims in order to efficiently generate the correct monitoring incentives. Self-enforcing monitoring leads to misreporting in equilibrium. While stochastic monitoring means that the failure to repay the face value of the debt can lead to either monitoring and “bankruptcy,” or the acceptance of a reduced payment, which corresponds to a settlement agreement.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0304393213000792
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Monetary Economics.

    Volume (Year): 60 (2013)
    Issue (Month): 6 ()
    Pages: 632-649

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    Handle: RePEc:eee:moneco:v:60:y:2013:i:6:p:632-649

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    Web page: http://www.elsevier.com/locate/inca/505566

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    7. Wang, Cheng, 2005. "Dynamic Costly State Verification," Staff General Research Papers 10832, Iowa State University, Department of Economics.
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    Cited by:
    1. Mikhail Dmitriev & Jonathan Hoddenbagh, 2013. "The Financial Accelerator and the Optimal Lending Contract," 2013 Papers pdm9, Job Market Papers.

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