Supervisory Incentives within Contracts: A Principal-Supervisor-Agent Approach

Abstract

This article aims at highlighting how supervisory incentives impact projects selection and the monitoring of borrowers in lending contracts. We focus on prominent forms of supervisor relationships in lending contracts: the endorsement given by an endorser and the sponsorship proposed by a sponsor. The method used is based on the framework of the principal-supervisor-agent model. We show that endorsement and sponsorship practices are powerful incentive for better monitoring of borrowers and a quality of project selection. The findings show that the agency problem within lending contract is efficiently addressed with the internal sponsorship and endorsement practices whith result in selecting the optimal project (with higher expected return and lower risk) and the optimal control of borrowers.