← Search

Incentive-Compatible Debt Contracts: The One-Period Problem

Douglas Gale¹; Martin Hellwig²

¹ University of Pennsylvania · ² University of Bonn

In a simple model of borrowing and lending with asymmetric information we show that the optimal, incentive-compatible debt contract is the standard debt contract. The second-best level of investment never exceeds the first-best and is strictly less when there is a positive probability of costly bankruptcy. We also compare the second-best with the results of interest-rate-taking behaviour and consider the effects of risk aversion. Finally we provide conditions under which increasing the borrower's initial net wealth must reduce total investment in the venture.

DOI

10.2307/2297737

Volume

52 (4)

Pages

647

Export

BibTeX

Sources

openalex crossref