Optimal Debt Contracts Under Costly Enforcement

Hvide, Hans K.; Leite, Tore E.

doi:10.2139/ssrn.782725

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Optimal Debt Contracts Under Costly Enforcement

25 Pages Posted: 18 Aug 2005 Last revised: 22 Apr 2015

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)

There are 2 versions of this paper

Date Written: April 15, 2008

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 behavior in credit markets.

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

JEL Classification: D02, D82, G21, G33

Suggested Citation: Suggested Citation

Hvide, Hans and Leite, Tore E., Optimal Debt Contracts Under Costly Enforcement (April 15, 2008). Available at SSRN: https://ssrn.com/abstract=782725 or http://dx.doi.org/10.2139/ssrn.782725