scholarly journals Optimal Contracts in a Dynamic Costly State Verification Model

2002 ◽  
Author(s):  
Cyril Monnet ◽  
Erwan Quintin
Keyword(s):  
Optimal Contracts ◽  
Costly State Verification ◽  
Verification Model

scholarly journals Optimal contracts in a dynamic costly state verification model

2005 ◽  
Vol 26 (4) ◽  
pp. 867-885 ◽  
Author(s):  
Cyril Monnet ◽  
Erwan Quintin
Keyword(s):  
Optimal Contracts ◽  
Costly State Verification ◽  
Verification Model

scholarly journals Disputes, debt, and equity

2019 ◽  
Vol 14 (3) ◽  
pp. 887-925 ◽  
Author(s):  
Alfred Duncan ◽  
Charles Nolan
Keyword(s):  
Incentive Contracts ◽  
Debt Financing ◽  
Risk Averse ◽  
Debt Contracts ◽  
Optimal Contracts ◽  
Costly State Verification ◽  
Highly Correlated ◽  
Verification Model

We show how the prospect of disputes over firms' revenue reports promotes debt financing over equity. This is demonstrated in a costly state verification model with a risk‐averse entrepreneur. The prospect of disputes encourages incentive contracts that limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic monitoring. Consequently, optimal contracts shift from equity toward standard debt. In short, when audit signals are weakly correlated with true incomes, standard debt contracts emerge as optimal; if audit signals are highly correlated with true incomes, optimal contracts resemble equity. When audit costs are sufficiently high, stochastic monitoring may be optimal. Optimal standard debt contracts under imperfect audits are shown to reproduce key empirical facts of U.S. firm borrowing.

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