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

Listed author(s):
  • 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.

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Article provided by Springer & Society for Economic Design in its journal Review of Economic Design.

Volume (Year): 3 (1998)
Issue (Month): 3 ()
Pages: 237-255

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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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