Journal Article

A Continuous-Time Version of the Principal-Agent Problem

Yuliy Sannikov

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 75, issue 3, pages 957-984
Published in print July 2008 | ISSN: 0034-6527
Published online July 2008 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2008.00486.x
A Continuous-Time Version of the Principal-Agent Problem

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  • Demand and Supply of Labour
  • Wages, Compensation, and Labour Costs
  • Information, Knowledge, and Uncertainy

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This paper describes a new continuous-time principal-agent model, in which the output is a diffusion process with drift determined by the agent's unobserved effort. The risk-averse agent receives consumption continuously. The optimal contract, based on the agent's continuation value as a state variable, is computed by a new method using a differential equation. During employment, the output path stochastically drives the agent's continuation value until it reaches a point that triggers retirement, quitting, replacement, or promotion. The paper explores how the dynamics of the agent's wages and effort, as well as the optimal mix of short-term and long-term incentives, depend on the contractual environment.

Keywords: D82; J26; J33

Journal Article.  12979 words.  Illustrated.

Subjects: Demand and Supply of Labour ; Wages, Compensation, and Labour Costs ; Information, Knowledge, and Uncertainy

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