Authors
Anna Maria C Menichini, Peter J Simmons
Publication date
2006/6/19
Journal
BE Journals in Theoretical Economics
Volume
6
Issue
1
Pages
1-21
Description
Within a costly state verification setting, we derive the optimal financial contract between an entrepreneur, a (potentially financing) supervisor and a pure investor when there is non-verifiable and non-contractible monitoring and limited liability. We show that diversion of cash flows to the entrepreneur arises as optimal behaviour and that to get the best reporting and monitoring incentives it is crucial to separate the financing from the monitoring role. In particular, higher efficiency can be achieved by ensuring that the entrepreneur and the supervisor do not collect any cash flows in low states. These should be paid to a third party instead, the pure investor, who in exchange provides funding. However, whether the pure investor entirely finances the project (and the supervisor purely acts as a monitor) or only provides partial finance (with the supervisor cofinancing) is immaterial, as the optimal financing of the project can …
Scholar articles
AMC Menichini, PJ Simmons - Contributions in Theoretical Economics, 2006