A mechanism design approach to an optimal contract under ex ante and ex post private information

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This paper applies a mechanism design approach to the problem of an optimal contract when one party has both ex ante and ex post private information. With ex ante private information added to the costly state verification environment, the timing of the contract is important in achieving the first-best investment decision. It is shown that an optimal contract involves precommitment, a feature often observed in many bank loan contracts. An optimal contract thus obtained is interpreted as the golden parachute, a device providing incentives to managers not to distort the running of a firm to fight takeover bids. In the process of characterizing an optimal contract, the revelation principle is re-examined.

Original languageEnglish
Pages (from-to)237-255
Number of pages19
JournalReview of Economic Design
Issue number3
Publication statusPublished - 1 Jan 1998
Externally publishedYes


  • Mechanism design
  • Optimal contract
  • Private information

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