Abstract:
We consider a dynamic renegotiation-proof financial contracting problem that arises when an entrepreneur seeks funding for a project whose cashflows are privately observed. We determine an optimal contract that induces truthful reporting, while leaving no scope for mutually beneficial ex post renegotiation. The contract involves the use of randomized liquidation if and only if the optimal `full-commitment’ contract a la DeMarzo & Sannikov (2006) is not renegotiation-proof. In this case, the entrepreneur’s continuation payoff, or promise, evolves between two boundary points as a reflected process. After good reported performance, the entrepreneur’s promise may reach an upper bound where he becomes sole claimant to the project cashflows. On the other hand, after poor reported performance, his promise may reach a lower bound where the project is randomly liquidated.
For more information about the speaker please see: Mihail Zervos Website LSE