Abstract
We consider a financing game where monitoring is costly, non-contractible and allowed to be stochastic. The optimal contract, which is debt, induces creditor leniency and strategic defaults on the equilibrium path, consistent with empirical evidence on repayment and monitoring behavior in credit markets. Our paper is the first where the optimal contract is debt and default is not synonymous with bankruptcy.
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We thank Arne-Christian Lund, Roland Strausz, and two anonymous referees for helpful comments.
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Hvide, H.K., Leite, T.E. Optimal debt contracts under costly enforcement. Econ Theory 44, 149–165 (2010). https://doi.org/10.1007/s00199-009-0461-1
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DOI: https://doi.org/10.1007/s00199-009-0461-1