scholarly journals Optimal dynamic contracting: The first‐order approach and beyond

2019 ◽  
Vol 14 (4) ◽  
pp. 1435-1482 ◽  
Author(s):  
Marco Battaglini ◽  
Rohit Lamba
Keyword(s):  
Stochastic Process ◽  
Time Horizon ◽  
Incentive Compatibility ◽  
Discount Factor ◽  
Principal Agent ◽  
Optimal Contract ◽  
Dynamic Contracting ◽  
First Order ◽  
Incentive Compatible ◽  
Optimal Dynamic

We explore the conditions under which the “first‐order approach” (FO approach) can be used to characterize profit maximizing contracts in dynamic principal–agent models. The FO approach works when the resulting FO‐optimal contract satisfies a particularly strong form of monotonicity in types, a condition that is satisfied in most of the solved examples studied in the literature. The main result of our paper is to show that except for nongeneric choices of the stochastic process governing the types' evolution, monotonicity and, more generally, incentive compatibility are necessarily violated by the FO‐optimal contract if the frequency of interactions is sufficiently high (or, equivalently, if the discount factor, time horizon, and persistence in types are sufficiently large). This suggests that the applicability of the FO approach is problematic in environments in which expected continuation values are important relative to per period payoffs. We also present conditions under which a class of incentive compatible contracts that can be easily characterized is approximately optimal.

scholarly journals Optimal Asset Management Contracts With Hidden Savings

Econometrica ◽  
2021 ◽  
Vol 89 (3) ◽  
pp. 1099-1139
Author(s):  
Sebastian Di Tella ◽  
Yuliy Sannikov
Keyword(s):  
Asset Management ◽  
Incentive Compatibility ◽  
Market Risk ◽  
Precautionary Saving ◽  
Sufficient Condition ◽  
Portfolio Investment ◽  
Optimal Contract ◽  
First Order ◽  
Management Contracts

We characterize optimal asset management contracts in a classic portfolio‐investment setting. When the agent has access to hidden savings, his incentives to misbehave depend on his precautionary saving motive. The contract dynamically distorts the agent's access to capital to manipulate his precautionary saving motive and reduce incentives for misbehavior. We provide a sufficient condition for the validity of the first‐order approach, which holds in the optimal contract: global incentive compatibility is ensured if the agent's precautionary saving motive weakens after bad outcomes. We extend our results to incorporate market risk, hidden investment, and renegotiation.

The Principal-Agent Approach to Testing Experts

2011 ◽  
Vol 3 (2) ◽  
pp. 89-113 ◽  
Author(s):  
Wojciech Olszewski ◽  
Marcin Pęski
Keyword(s):  
Stochastic Process ◽  
Decision Maker ◽  
Recent Literature ◽  
Infinite Horizon ◽  
Discount Factor ◽  
Principal Agent ◽  
Surplus Extraction ◽  
Full Surplus Extraction

Recent literature on testing experts shows that it is often impossible to determine whether an expert knows the stochastic process that generates data. Despite this negative result, we show that there often exist contracts that allow a decision maker to attain the first-best payoff without learning the expert's type. This kind of full-surplus extraction is always possible in infinite-horizon models in which future payoffs are not discounted. If future payoffs are discounted (but the discount factor tends to 1), the possibility of full-surplus extraction depends on a constraint involving the forecasting technology. (JEL D82)

Optimal Dynamic Contracting

2012 ◽  
Author(s):  
Marco Battaglini ◽  
Rohit Lamba
Keyword(s):  
Dynamic Contracting ◽  
Optimal Dynamic

Stock and Option Proportions in Executive Compensation

2011 ◽  
Vol 01 (01) ◽  
pp. 169-203 ◽  
Author(s):  
Phelim P. Boyle ◽  
Ranjini Jha ◽  
Shannon Kennedy ◽  
Weidong Tian
Keyword(s):  
Executive Compensation ◽  
Empirical Evidence ◽  
Risk Taking ◽  
Principal Agent ◽  
Optimal Contract ◽  
Efficient Mechanism ◽  
Opposite Conclusion

There is controversy about the relative merits of stock and options in executive compensation. Some observers contend that stock is a more efficient mechanism, while others reach the opposite conclusion. We focus on the manager's risk-taking incentives and derive an optimal compensation contract by using the concept of a comparable benchmark and imposing a volatility constraint in a principal-agent framework. We demonstrate a joint role for both stock and options in the optimal contract. We show that firms with higher volatility should use more options in compensating their executives and provide empirical evidence supporting this testable implication.

scholarly journals Experimental tests for gender effects in a principal-agent game

2019 ◽  
Vol 2 (1) ◽  
Author(s):  
Andrew B Whitford ◽  
Holona L Ochs
Keyword(s):  
Laboratory Test ◽  
Experimental Tests ◽  
Gender Effects ◽  
Principal Agent ◽  
Wage Labor ◽  
Optimal Contract ◽  
Men And Women ◽  
Perceived Trust ◽  
Labor Agreement ◽  
Bargaining Position

Traditional arguments against women as leaders suggest that women would not be extended the trust necessary for leadership and/or that women undermine their own bargaining position by extending too much trust to others. We examine data from a laboratory test in which pairs of subjects are given the task of negotiating a wage-labor agreement.  We first derive the optimal contract offer for principals and response by agents. We find that men and women do not reach different bargaining outcomes. We also find that women in authority are perceived as more trustworthy than men with authority, and women are no more or less trusting than men of their superiors or subordinates. The perceived trust is not rooted in differential wage terms but is based on the negotiation setting. Thus, women are likely to be extended the trust necessary to lead and are not likely to produce outcomes that are significantly different from men.

Principals and Agents: From the Convention’s Proposal to the Constitutional Treaty

2012 ◽  
Author(s):  
Thomas König ◽  
Daniel Finke
Keyword(s):  
Final Outcome ◽  
The Political ◽  
Principal Agent ◽  
Constitutional Treaty ◽  
Political Leaders ◽  
Voting Rules ◽  
Common View ◽  
Treaty Of Lisbon ◽  
First Order ◽  
The Common

This chapter examines the transformation of the Convention's proposal on the Treaty Establishing a Constitution for Europe to the Lisbon Treaty in the aftermath of the two negative referendums from a principal-agent perspective. It shows that the common view of unitary member states, in which principals and agents share interests in the revision of treaties, can only partially—if not wrongly—explain the Treaty of Lisbon. The principal-agent analysis reveals that the political leaders delegated power to negotiating agents who worked out compromise solutions by partially revising the initial interests of their first order principals, the political leaders. Governmental agents from smaller countries were able to focus the negotiations on a few central reform issues, such as the number of Commissioners and the voting rules of the Council, and they also successfully influenced the final outcome of these issues. A major reason for their success was their credibility, which they could increase by pointing to integration-skeptic voters—particularly in countries that had announced a referendum. Hence, governmental agents increased their bargaining efficiency by referring to voters as their second-order principals.

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