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A mechanism design approach to an optimal contract under ex ante and ex post private information

Author

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  • C. Choe

    (Department of Economics, School of Business, La Trobe University, Melbourne, Victoria 3083, Australia)

Abstract

This paper applies a mechanism design approach to the problem of an optimal contract when one party has both ex ante and ex post private information. With ex ante private information added to the costly state verification environment, the timing of the contract is important in achieving the first-best investment decision. It is shown that an optimal contract involves precommitment, a feature often observed in many bank loan contracts. An optimal contract thus obtained is interpreted as t he golden parachute, a device providing incentives to managers not to distort the running of a firm to fight takeover bids. In the process of characterizing an optimal contract, the revelation principle is re-examined.

Suggested Citation

  • C. Choe, 1998. "A mechanism design approach to an optimal contract under ex ante and ex post private information," Review of Economic Design, Springer;Society for Economic Design, vol. 3(3), pages 237-255.
    • Handle: RePEc:spr:reecde:v:3:y:1998:i:3:p:237-255
    Note: Received: 12 April 1996 / Accepted: 3 December 1997
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    Citations

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    Cited by:

    1. Fabienne Llense, 2009. "Taxes on severance pay, corporate governance and golden handshakes," Post-Print halshs-00441911, HAL.
    2. Attar, Andrea & Campioni, Eloisa, 2003. "Costly state verification and debt contracts: a critical resume," Research in Economics, Elsevier, vol. 57(4), pages 315-343, December.
    3. Praveen Kumar & Nisan Langberg, 2009. "Corporate fraud and investment distortions in efficient capital markets," RAND Journal of Economics, RAND Corporation, vol. 40(1), pages 144-172, March.
    4. Chongwoo Choe, 2006. "Optimal CEO Compensation: Some Equivalence Results," Journal of Labor Economics, University of Chicago Press, vol. 24(1), pages 171-201, January.
    5. ATTAR, Andréa, 2003. "Financial contracting along the business cycle," LIDAM Discussion Papers CORE 2003069, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. Enrico Minelli & Salvatore Modica, 2009. "Credit Market Failures and Policy," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 11(3), pages 363-382, June.
    7. Iossa, Elisabetta, 2001. "Third Party Monitoring and Golden Parachutes," CEPR Discussion Papers 2777, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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