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A mechanism design approach to an optimal contract under ex ante and ex post private information


  • C. Choe

    () (Department of Economics, School of Business, La Trobe University, Melbourne, Victoria 3083, Australia)


This paper applies a mechanism design approach to the problem of an optimal contract when one party has both ex ante and ex post private information. With ex ante private information added to the costly state verification environment, the timing of the contract is important in achieving the first-best investment decision. It is shown that an optimal contract involves precommitment, a feature often observed in many bank loan contracts. An optimal contract thus obtained is interpreted as t he golden parachute, a device providing incentives to managers not to distort the running of a firm to fight takeover bids. In the process of characterizing an optimal contract, the revelation principle is re-examined.

Suggested Citation

  • C. Choe, 1998. "A mechanism design approach to an optimal contract under ex ante and ex post private information," Review of Economic Design, Springer;Society for Economic Design, vol. 3(3), pages 237-255.
  • Handle: RePEc:spr:reecde:v:3:y:1998:i:3:p:237-255 Note: Received: 12 April 1996 / Accepted: 3 December 1997

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    References listed on IDEAS

    1. Warr, Peter G., 1983. "The private provision of a public good is independent of the distribution of income," Economics Letters, Elsevier, vol. 13(2-3), pages 207-211.
    2. Warr, Peter G., 1982. "Pareto optimal redistribution and private charity," Journal of Public Economics, Elsevier, vol. 19(1), pages 131-138, October.
    3. Bergstrom, Theodore & Blume, Lawrence & Varian, Hal, 1986. "On the private provision of public goods," Journal of Public Economics, Elsevier, vol. 29(1), pages 25-49, February.
    4. Bernheim, B Douglas, 1986. "On the Voluntary and Involuntary Provision of Public Goods," American Economic Review, American Economic Association, vol. 76(4), pages 789-793, September.
    5. Sugden, Robert, 1985. "Consistent conjectures and voluntary contributions to public goods: why the conventional theory does not work," Journal of Public Economics, Elsevier, vol. 27(1), pages 117-124, June.
    6. Cornes, Richard & Sandler, Todd, 1984. "The theory of public goods: non-nash behaviour," Journal of Public Economics, Elsevier, vol. 23(3), pages 367-379, April.
    7. Saijo, Tatsuyoshi, 1991. "Incentive compatibility and individual rationality in public good economies," Journal of Economic Theory, Elsevier, vol. 55(1), pages 203-212, October.
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    Cited by:

    1. repec:hal:journl:halshs-00441911 is not listed on IDEAS
    2. Attar, Andrea & Campioni, Eloisa, 2003. "Costly state verification and debt contracts: a critical resume," Research in Economics, Elsevier, vol. 57(4), pages 315-343, December.
    3. Praveen Kumar & Nisan Langberg, 2009. "Corporate fraud and investment distortions in efficient capital markets," RAND Journal of Economics, RAND Corporation, vol. 40(1), pages 144-172.
    4. Chongwoo Choe, 2006. "Optimal CEO Compensation: Some Equivalence Results," Journal of Labor Economics, University of Chicago Press, vol. 24(1), pages 171-201, January.
    5. ATTAR, Andréa, 2003. "Financial contracting along the business cycle," CORE Discussion Papers 2003069, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. Enrico Minelli & Salvatore Modica, 2009. "Credit Market Failures and Policy," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 11(3), pages 363-382, June.
    7. Iossa, Elisabetta & Legros, Patrick, 2001. "Third Party Monitoring and Golden Parachutes," CEPR Discussion Papers 2777, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General


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