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Costly monitoring, dynamic incentives, and default

Listed author(s):
  • Antinolfi, Gaetano
  • Carli, Francesco

We study dynamic contracts between a lender and a borrower in the presence of costly state verification and hidden effort. We prove three results. Costly monitoring is employed by the lender to optimally limit history dependence and prevent future inefficient termination of the relationship. Due to interaction between costly monitoring and dynamic incentives, the probability of monitoring may fail to be monotone in the borrower's reservation utility. Finally, following the interpretation of the costly state verification literature, we distinguish two levels of bankruptcy: one associated with restructuring and the other with liquidation.

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File URL: http://www.sciencedirect.com/science/article/pii/S0022053115000903
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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 159 (2015)
Issue (Month): PA ()
Pages: 105-119

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Handle: RePEc:eee:jetheo:v:159:y:2015:i:pa:p:105-119
DOI: 10.1016/j.jet.2015.05.011
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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