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Optimal Contracts when Enforcement Is a Decision Variable


  • Stefan Krasa
  • Anne P. Villamil


The paper analyzes choice-theoretic costly enforcement in an intertemporal contracting model with a differentially informed investor and entrepreneur. An intertemporal contract is modeled as a mechanism with limited commitment to payment and enforcement decisions. The paper shows that simple debt is the optimal contract when commitment is limited and costly enforcement is a decision variable. In contrast, stochastic contracts are optimal when agents can commit to the ex-ante optimal decisions. The paper also shows that the Costly State Verification model can be viewed as a reduced form of an enforcement model.

Suggested Citation

  • Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  • Handle: RePEc:ecm:emetrp:v:68:y:2000:i:1:p:119-134

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    References listed on IDEAS

    1. Milgrom, Paul R & Weber, Robert J, 1982. "A Theory of Auctions and Competitive Bidding," Econometrica, Econometric Society, vol. 50(5), pages 1089-1122, September.
    2. Robert Wilson, 1977. "A Bidding Model of Perfect Competition," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 511-518.
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