We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behavior in credit markets.
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Paper provided by Department of Finance and Management Science, Norwegian School of Economics and Business Administration in its series Discussion Papers with number
2005/4.
Length: 21 pages Date of creation: 12 Sep 2005 Date of revision: Handle: RePEc:hhs:nhhfms:2005_004
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