Optimal Debt Contracts Under Costly Enforcement

26 Pages Posted: 27 Jun 2007

See all articles by Hans K. Hvide

Hans K. Hvide

University of Bergen - Department of Economics; University of Aberdeen - Business School; Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)

Tore E. Leite

Norwegian School of Economics (NHH)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2007

Abstract

We consider a financing game with costly enforcement based on Townsend (1979), but where monitoring is non-contractible and allowed to be stochastic. Debt is the optimal contract. Moreover, the debt contract induces creditor leniency and strategic defaults by the borrower on the equilibrium path, consistent with empirical evidence on repayment and monitoring behaviour in credit markets.

Keywords: Costly state verification, debt contract, priority violation, strategic defaults

Suggested Citation

Hvide, Hans and Leite, Tore E., Optimal Debt Contracts Under Costly Enforcement (January 2007). CEPR Discussion Paper No. 6040. Available at SSRN: https://ssrn.com/abstract=996911

Hans Hvide (Contact Author)

University of Bergen - Department of Economics ( email )

Fosswinckelsgt. 6
N-5007 Bergen, 5007
Norway

University of Aberdeen - Business School ( email )

Edward Wright Building
Dunbar Street
Aberdeen, Scotland AB24 3QY
United Kingdom

HOME PAGE: http://hans.hvide.googlepages.com/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Institute for the Study of Labor (IZA) ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Tore E. Leite

Norwegian School of Economics (NHH) ( email )

Helleveien 30
N-5045 Bergen
Norway
+47 5595 9343 (Phone)
+47 5595 9841 (Fax)

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