Self-Enforcing Stochastic Monitoring and the Separation of Debt and Equity Claims
AbstractThis paper studies the incentive issues associated with self-enforcing stochastic monitoring in a model of investment and production. The efficient contract features a debt-like payment with a threshold in terms of the reported output in which all of the reported output is taken up to the threshold if monitoring doesn't occur and all of the output is taken if monitoring does occur. An output report above the threshold leads to zero probability of monitoring and just the threshold amount being paid out. The efficiency gap between the self-enforcing contract and the commitment constraint is minimized when the monitors hold no part of the residual claim on the firm, which we associate with equity. Misreporting by the manager is an important component of the efficient contract.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14480.
Date of creation: Nov 2008
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Other versions of this item:
- Harold L. Cole, 2008. "Self-Enforcing Stochastic Monitoring and the Separation of Debt and Equity Claims," PIER Working Paper Archive 08-025, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
- G3 - Financial Economics - - Corporate Finance and Governance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-11-18 (All new papers)
- NEP-BEC-2008-11-18 (Business Economics)
- NEP-CTA-2008-11-18 (Contract Theory & Applications)
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