Unformatted text preview: an optimal debt contract where in exchange for 1 unit of investment good lent to the entrepreneur at the beginning of the period, the lender receives return B ( x ) ∈ [0 , x ] if the entrepreneur reports e x ∈ S ⊂ [0 , x ] and the lender veri f es the report while the lender receives R ( e x ) if the entrepreneur reports e x ∈ S c and the lender does not verify. 1. Prove that R ( e x ) must be a constant (say R ) on e x ∈ S c . 2. State the programming problem which maximizes the entrepreneur’s utility subject to participation by the lender. 3. Prove that the veri f cation region S = { e x : e x ∈ [0 , x ∗ ] } (i.e. a lower interval). 4. Prove that B ( x ) = x < R. Note that (1)(4) implies that the optimal contract has all the essential features of a debt contract where veri f cation can be interpreted as bankruptcy. 1...
View
Full Document
 Spring '07
 CORBAE
 Economics, Verification, Department of Economics, Dean Corbae, risk neutral entrepreneur, risk neutral lender

Click to edit the document details