Optimal contracts when enforcement is a decision variable

Stefan Krasa, Anne P. Villamil

Research output: Contribution to journalArticlepeer-review

Abstract

This paper analyzes choice-theoretic costly enforcement in an intertemporal contracting model with a differentially informed investor and entrepreneur. An intertemporal contract is modeled as a mechanism in which there is limited commitment to payment and enforcement decisions. The goal of the analysis is to characterize the effect of choice-theoretic costly enforcement on the structure of optimal contracts. The paper shows that simple debt is the optimal contract when commitment is limited and costly enforcement is a decision variable (Theorem 1). In contrast, stochastic contracts are optimal when agents can commit to the ex-ante optimal decisions (Theorem 2). The paper also shows that the costly state verification model can be viewed as a reduced form of an enforcement model in which agents choose payments and strategies as part of a perfect Bayesian Nash equilibrium.

Original languageEnglish (US)
Pages (from-to)119-134
Number of pages16
JournalEconometrica
Volume68
Issue number1
DOIs
StatePublished - Jan 1 2000
Externally publishedYes

Keywords

  • Contracts
  • Costly state verification
  • Debt
  • Enforcement
  • Limited commitment
  • Renegotiation
  • Stochastic monitoring
  • Time consistency

ASJC Scopus subject areas

  • Economics and Econometrics

Fingerprint

Dive into the research topics of 'Optimal contracts when enforcement is a decision variable'. Together they form a unique fingerprint.

Cite this