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Optimal contracts and competitive markets with costly state verification

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Townsend, Robert M·1979·Journal of Economic Theory
DOI 10.1016/0022-0531(79)90031-0

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Abstract

The insight of Arrow [4] and Debreu [7] that uncertainty is easily incor-porated into general equilibrium models is double-edged. It is true that one need only index commodities by the state of nature, and classical results on the existence and optimality of competitive equilibria can be made to

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  • Costly state verification and adverse selection arguments suggest the optimality of debt contracts after insider finance has been exhausted.

    “Costly state veri®cation (Townsend, 1979;Diamond, 1984) and adverse selection (Myers, 1984;Myers and Majluf, 1984;Nachman and Noe, 1994) arguments suggest the optimality of debt contracts after insider ®nance has been exhausted.”

    From The economics of small business finance: The roles of private equity and debt markets in the financial growth cycle (1998) · cites this paper as Townsend, 1979

    Section 3 characterizes an optimal contract for a firm financing an investment project as a bond that defaults when returns fall below a threshold, supporting the costly-state-verification rationale for debt. The paper does not establish that debt becomes optimal only after insider finance has been exhausted. The adverse-selection citations in the sentence refer to other sources, not Townsend. (LLM, conf=0.85)

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Research works printed but not linked: 14

  1. [1]1. K. J. Arrow, Limited information and economic analysis, Amer. Econ. Rev. 64 (1974), 1-10.
  2. [4]4. The role of securities in the optimal allocations of risk bearing, Rev. Econ. Studies 31 (1964), 91-96.
  3. [7]7. G. Debreu, "Theory of Value," New York, John Wiley and Sons, 1959.
  4. [11]11. E. Helpman and J. Laffont, On moral hazard in general equilibrium theory, J. Econ. Theory 10 (1975), 8-23.
  5. [12]12. J. Hirshleifer, The private and social value of information and the reward to inventive activity, Amer. Econ. Rev. 61-3 (1971), 561-574.
  6. [13]13. L. Hurwicz, On informationally decentralized systems, Chapter 14 of "Decision and Organization," C. B. McGuire and R. Radner, eds., Amsterdam, North Holland, 1972.
  7. [14]14. R. Kihlstrom and M. Pauly, The role of insurance in the allocation of risk, Amer. Econ. Rev. 61 (1971), 371-379.
  8. [16]16. R. Radner, Competitive equilibrium under uncertainty, Econometrica 36 (1968), 31-58.
  9. [17]17. A. Raviv, "Mathematical Models for Optimal Insurance Policy Selection," Ph.D. dissertation, Northwestern University, 1975.
  10. [18]18. S. Ross, The determination of financial structure: the incentive-signalling approach, Bel1 J. Econ. 8-1 (1977), 23-40.
  11. [19]19. M. Rothschild and J. Stiglitz, Increasing risk I: a definition, J. Econ. Theory 2 (1970), 225-243.
  12. [21]21. M. Spence and R. Zeckhauser, Insurance, information and individual action, Amer. Econ. Rev. 61 (1971), 380-387.
  13. [22]22. R. Wilson, Informational economies of scale, Bell J. Econ. 6-1 (1975), 184-195.
  14. [23]23. , On the theory of syndicates, Econometrica 36-1 (1968), 119-132. Figure 1a <!-- image --> <!-- image -->

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Authors
Townsend, R. M.
Affiliations
Carnegie Mellon University (US)
Corresponding author
Townsend, Robert M
ORCID
Townsend, Robert M
Venue
Journal of Economic Theory
Publisher
Elsevier BV
Published
1979-10
Volume
21
Issue
2
Pages
265-293
ISSN
0022-0531 (ISSN-L)
DOI
10.1016/0022-0531(79)90031-0
OpenAlex
W2147560556
Cited by
3,204
References
0
Citations by year
2026: 78 · 2025: 86 · 2024: 68 · 2023: 59 · 2022: 61 · 2021: 87 · 2020: 125 · 2019: 88 · 2018: 105 · 2017: 106 · 2016: 135 · 2015: 146 · 2014: 125 · 2013: 144 · 2012: 145
FWCI
14.77
Type
journal article
Language
en
Open access
Licence
Locations
  • Journal of Economic Theory (publishedVersion)
  • RePEc: Research Papers in Economics (submittedVersion)
Topics
  • Social Sciences › Economics, Econometrics and Finance › Economics and Econometrics › Economic theories and models
  • Social Sciences › Economics, Econometrics and Finance › Economics and Econometrics › Law, Economics, and Judicial Systems
  • Social Sciences › Decision Sciences › Management Science and Operations Research › Game Theory and Applications
Keywords
optimal contracts, competitive markets, costly state verification, uncertainty, general equilibrium, contract theory, information asymmetry

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