We study how the efficient choice of contract enforcement interacts with the efficient allocation of capital in a simple production economy. Contract enforcement makes trade possible but requires an aggregate investment of capital that is no longer available for production. In such an economy,...

This paper describes optimal contracts in a dynamic costly state verification model with stochastic monitoring. An agent operates a risky project on behalf of a principal who can observe the project’s revenues at a cost. We show that an optimal contract exists such that, at any history, either...