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Optimal Debt Contracts when Credit Managers are (Perhaps) Corruptible

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  • Ingela Alger

    (Boston College)

Abstract

The paper derives the optimal organizational response of a bank (the principal) which faces a risk of collusion between the credit manager (the agent) and the credit-seeking firms. The bank can deter collusion either through internal incentives or by distorting the credit contracts. The model thus explicitly takes into account the interaction between internal (collusion) risks and external (default) risks in the optimal design of the internal organization as well as of the credit contracts. We investigate this question in two settings. In the first one, we adopt the standard assumption that the agent is always willing to collude (is corruptible) if that increases his monetary payoff. In the second one, he is corruptible with some probability only, and honest otherwise. A novel feature of our approach is to allow for screening among corruptible and honest agents. We find that if the probability that the agent is honest is sufficiently large, collusion occurs in equilibrium.

Suggested Citation

  • Ingela Alger, 2006. "Optimal Debt Contracts when Credit Managers are (Perhaps) Corruptible," Boston College Working Papers in Economics 648, Boston College Department of Economics.
    • Handle: RePEc:boc:bocoec:648
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    References listed on IDEAS

    as
    1. Daron Acemoglu, 1994. "Monitoring and Collusion: "Carrots" versus "Sticks" in the Control of Auditors," Working papers 94-9, Massachusetts Institute of Technology (MIT), Department of Economics.
    2. Jean-Jacques Laffont & David Martimort, 1999. "Separation of Regulators Against Collusive Behavior," RAND Journal of Economics, The RAND Corporation, vol. 30(2), pages 232-262, Summer.
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    4. Jean-Jacques Laffont & David Martimort, 1998. "Collusion and Delegation," RAND Journal of Economics, The RAND Corporation, vol. 29(2), pages 280-305, Summer.
    5. Kofman, Fred & Lawarree, Jacques, 1993. "Collusion in Hierarchical Agency," Econometrica, Econometric Society, vol. 61(3), pages 629-656, May.
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    9. repec:bla:ecorec:v:64:y:1988:i:187:p:295-306 is not listed on IDEAS
    10. Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 51(3), pages 393-414.
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    13. Khalil, Fahad & Lawarree, Jacques, 1995. "Collusive Auditors," American Economic Review, American Economic Association, vol. 85(2), pages 442-446, May.
    14. Douglas Gale & Martin Hellwig, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(4), pages 647-663.
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