Review of Economic Studies Vol. 52 No. 4 1985
Incentive-Compatible Debt Contracts: The One-Period Problem
Abstract
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
- Issue
- 4
- Pages
- 647
- Sources
- openalex crossref