Abstract: Based on the moral hazard problem in H lmstrom's (1999) and the multi-stage modeling in Laffont and Tirole (1988), this paper constructs an optimal supervision contract that takes into account local governments' moral hazard and the central government's implicit debt guarantee under single-period and two-period cases. It gives a general framework of the central government optimal supervision contract design and then uses numerical examples to verify the theoretical results. The results show that the central government can provide effective incentives for local governments to increase their efforts by linking the central government's sharing rules with local governments' efforts under the single-period case, which contributes to the improvement of social welfare. Considering the reputation effect, local governments will work harder at the first period in the two-period context than that in the one-stage context. The study provides a theoretical basis for the central government to design the regulatory mechanism for the bond issuance by local governments. This paper also provides many implications for the central government to design its supervision strategies based on specific local governments' conditions.

Key words: moral hazard, implicit guarantee, optimal regulation contract, reputation effect, local government debt