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One-Sided Enforcement in a Model with Persistent Adverse Selection

Author

Listed:
  • Martimort, David
  • Simons (Semenov), Aggey

Abstract

We study a repeated buyer-seller relationship with persistent adverse selection and one-sided enforcement, where a prepaid seller can breach by taking the money and running. The optimal stationary contract depends on enforcement strength and the discount factor. Three regimes arise. With a strong legal system, penalties deter breach and the optimal static contract can be repeated. With a weak system, the penalty caps transfers, forcing bunching among efficient (low-cost) types. With a very weak system, compliance relies on relational rents, causing large downward distortions. Strengthening public enforcement relaxes both incentive and enforcement constraints, reducing allocative inefficiency.

Suggested Citation

  • Martimort, David & Simons (Semenov), Aggey, 2026. "One-Sided Enforcement in a Model with Persistent Adverse Selection," TSE Working Papers 26-1704, Toulouse School of Economics (TSE).
    • Handle: RePEc:tse:wpaper:131355
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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
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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