Costly state verification
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Costly State Verification (CSV) approach in contract theory considers contract design problem in which verification (or disclosure) of enterprise performance is costly and a lender has to pay a monitoring cost.
A central result of CSV approach is that it is generally optimal to commit to a partial, state-contingent disclosure rule. Townsend (1979) has shown that under few strong assumptions the optimal financing mechanism is a standard debt contract for which there is no disclosure of the debtor's performance as long as debt as honored, but there is full disclosure (verification) in case of default.
See also
References
- Townsend, R.M., 1979. Optimal contracts and competitive markets with costly state verification. Journal of Economic Theory 22, 265–293.
- Bolton, Patrick and Dewatripont, Mathias. Contract Theory. MIT press, 2005.