Loan Size as a Commitment Device
The authors model risky lending with costly state verification but without commitment to an audit strategy. The borrower underreports with a positive probability in the successful state and the lender audits with a positive probability after a report of failure. Under lack of commitment to audit probabilities, an increase in loan size convinces the borrower that the lender has a high stake in an audit. This reduces the probability of underreporting and leads to overinvestment relative to the commitment case. However, there is underinvestment relative to the level under full information. Copyright 1998 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
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Volume (Year): 39 (1998)
Issue (Month): 1 (February)
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