LOAN SIZE AS A COMMITMENT DEVICE

We model risky lending with costly state verification, but without com mitment to an audit strategy. The borrower under-reports with a positi ve probability in the successful state, and the lender audits with a p ositive probability after a report of failure. Under lack of commitmen t to audit probabilities, an increase in loan size convinces the borro wer that the lender has a high stake in an audit. This reduces the pro bability of under-reporting and leads to overinvestment relative to th e commitment case. However, there is under-investment relative to the level under full information.