FINANCIAL SECTOR REFORMS
375
14.1.3
Ex post
State Verification
When the outcome of a venture is not apparent to all the parties to a financial
contract, the uninformed may have to expend resources confirming this rather
than believing what they are told by the informed party. These are known as
audit costs
. Thus, for example, an equity contract allows outside investors to
share in the outcome of an investment. However, only insiders may know the
true outcome, and they have an
INCENTIVE
TO
UNDERSTATE
this in order to minimize
the distribution to outsiders.
Debt contracts offer a return that is independent of the outcome of a ...
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