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Optimal contracts in a dynamic costly state verification model

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Author Info
Cyril Monnet ()
Erwan Quintin ()

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Abstract

This paper describes optimal contracts in a dynamic costly state verification model with stochastic monitoring. An agent operates a risky project on behalf of a principal who can observe the project’s revenues at a cost. We show that an optimal contract exists such that, at any history, either the principal claims the project’s entire revenues or promises to claim nothing in the future. In particular, the agent’s expected income rises with time. Moreover, except in at most one period, the principal claims all revenues when audit occurs. We provide conditions under which all optimal contracts satisfy these properties. Copyright Springer-Verlag Berlin/Heidelberg 2005

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Publisher Info
Article provided by Springer in its journal Economic Theory.

Volume (Year): 26 (2005)
Issue (Month): 4 (November)
Pages: 867-885
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Handle: RePEc:spr:joecth:v:26:y:2005:i:4:p:867-885

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Related research
Keywords: Dynamic contracts; Theory of uncertainty and information; Costly state verification; Monitoring.;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Albuquerque, R. & Hopenhayn, H.A., 1997. "Optimal Dynamic Lending Contracts with Imperfect Enforceability," RCER Working Papers 439, University of Rochester - Center for Economic Research (RCER).
  2. Cooley, Thomas F & Marimon, Ramon & Quadrini, Vincenzo, 2004. "Aggregate Consequences of Limited Contract Enforceability," CEPR Discussion Papers 4173, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Smith, Bruce D. & Wang, Cheng, 1998. "Repeated insurance relationships in a costly state verification model: With an application to deposit insurance," Journal of Monetary Economics, Elsevier, vol. 42(2), pages 207-240, July. [Downloadable!] (restricted)
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  4. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Blackwell Publishing, vol. 54(4), pages 599-617, October. [Downloadable!] (restricted)
  5. Border, Kim C & Sobel, Joel, 1987. "Samurai Accountant: A Theory of Auditing and Plunder," Review of Economic Studies, Blackwell Publishing, vol. 54(4), pages 525-40, October. [Downloadable!] (restricted)
  6. Chang, Chun, 1990. "The dynamic structure of optimal debt contracts," Journal of Economic Theory, Elsevier, vol. 52(1), pages 68-86, October. [Downloadable!] (restricted)
  7. Mookherjee, Dilip & Png, Ivan, 1989. "Optimal Auditing, Insurance, and Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 399-415, May. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

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  4. Harold L. Cole, 2008. "Self-Enforcing Stochastic Monitoring and the Separation of Debt and Equity Claims," NBER Working Papers 14480, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Edward Simpson Prescott, 2004. "Auditing and bank capital regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 47-63. [Downloadable!]
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