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Optimal Contracts under Costly State Falsification

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Author Info
Lacker, Jeffrey M
Weinberg, John A

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Abstract

We examine an exchange economy with two agents: one risk neutral with a certain endowment and a second risk averse with a random endowment. The realization of the endowment is public but can be falsified by the second agent at a cost. For a broad class of falsification cost functions the optimal no-falsification contract is noncontingent on a left-hand interval and strictly increasing with a slope strictly less than one on a right-hand interval. Under a mild further restriction, optimal no-falsification contracts are, in addition, piecewise linear. Optimal contracts may in general require falsifying the state, but for a set of the highest endowment realizations there is no falsification. We find simple conditions under which the optimal contract is a i no-falsification contract. Copyright 1989 by University of Chicago Press.

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Publisher Info
Article provided by University of Chicago Press in its journal Journal of Political Economy.

Volume (Year): 97 (1989)
Issue (Month): 6 (December)
Pages: 1345-63
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Handle: RePEc:ucp:jpolec:v:97:y:1989:i:6:p:1345-63

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