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Optimal Stationary Contracts under One-Sided Enforcement and Persistent Adverse Selection

Author

Listed:
  • David Martimort

    (Toulouse School of Economics, France)

  • Aggey Simons

    (Department of Economics, University of Ottawa, Canada)

Abstract

We characterize the optimal contract within the class of stationary mechanisms in a repeated buyer-seller relationship with persistent adverse selection and one-sided limited enforcement. A prepaid seller may breach after receiving the current transfer and terminate the relationship upon paying an enforceable penalty. In this stationary benchmark, the enforcement problem collapses to a bound on the transfer targeted to the most efficient type. This yields a three-regime characterization. With strong enforcement, the repeated static second-best contract is feasible. With weak (intermediate) enforcement, the top transfer is capped, inducing bunching among efficient types and additional downward distortions. With very weak enforcement, public penalties alone cannot sustain compliance, and the principal must leave strictly positive continuation rents, including for the least efficient type. We interpret the associated distortion as a virtual enforcement cost.

Suggested Citation

  • David Martimort & Aggey Simons, 2026. "Optimal Stationary Contracts under One-Sided Enforcement and Persistent Adverse Selection," Working Papers 2603E, University of Ottawa, Department of Economics.
    • Handle: RePEc:ott:wpaper:2603e
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    File URL: http://hdl.handle.net/10393/51520
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    References listed on IDEAS

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    1. Rocco Macchiavello & Ameet Morjaria, 2015. "The Value of Relationships: Evidence from a Supply Shock to Kenyan Rose Exports," American Economic Review, American Economic Association, vol. 105(9), pages 2911-2945, September.
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    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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