Disputes, debt, and equity

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.

The impact of auditing strategies on insurers’ profitability

Purpose – The purpose of this paper paper is to study effective measures in dealing with the phenomenon of insurance claims’ fraud. In fact, fraud is one of the major industry concerns. It occurs in all classes of insurance and accounts for a substantial portion of indemnity payments each year. Design/methodology/approach – This paper develops a model framework based on a costly state verification setting in which – while policyholders observe the amount of loss privately – the insurance company can decide to audit incoming claims at some cost. The aim is to derive optimal auditing strategies from the insurance company’s perspective while maintaining contract attractiveness to policyholders willing to adhere to the insurance relationship. The possibility for each stakeholder to adapt its behavioral strategy over the course of several periods is taken into account. Using a numerical approach based on Monte Carlo simulations, the impact of different parameterizations on the optimal auditing range by means of a sensitivity analysis is illustrated and analyzed. Findings – The central outcome of the model is an auditing range which selects those claims which should be subject to verification. Practical implications – This paper comes to the conclusion that, given some constant cost per audit, it is optimal to verify the accuracy of claims from the mid-value segment. Furthermore, it can be shown that while the option to adapt one’s strategy might be favorable from the insurance company perspective, it has a negative impact on the policyholders’ position. This disproves the common belief that adapting the defrauding strategy with the help of signals from service providers would be advantageous. Originality/value – This paper extends the stand of literature on costly state verification and gives indications for optimal auditing strategies in industry practice.

Wybrane teorie umów kredytowych – przegląd badań

The article reviews theoretical studies on the loan agreement. First, the resultsof researches in the area of the costly state verification models proving optimalityof the standard debt contract in conditions of information asymmetry and existence of costs of verification of the debtor’s outcomes were analysed. Followedby analysis of the models included in the mainstream of the incomplete contracttheory, which assume unpredictability of nature and the need to take into accountthe role of collateral and the liquidation value on the loan repayment. The focuswas also placed on researches taking into account the impact of debt renegotiationand long lender-borrower relationship on the behaviour of the borrower duringthe repayment of the debt.