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Linearity with Project Selection and Controllable Diffusion Rate in Continuous-Time Principal-Agent Problems

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  • Jaeyoung Sung
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    Abstract

    I extend Holmstrom and Milgrom's model by allowing the agent to control privately or publicly the diffusion-rate process, and show that the optimal contract is still linear. I discuss the conditions under which conflicts over the choice of diffusion rate do and do not arise. As an application, I examine project- selection problems of a firm. Conflicts between the manager and investors arise because giving the manager too much incentive to work to increase the profit from ongoing operations can induce him to be too conservative in project selection, possibly resulting in optimal contracts with low sensitivities.

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    Bibliographic Info

    Article provided by The RAND Corporation in its journal RAND Journal of Economics.

    Volume (Year): 26 (1995)
    Issue (Month): 4 (Winter)
    Pages: 720-743

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    Handle: RePEc:rje:randje:v:26:y:1995:i:winter:p:720-743

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    Cited by:
    1. Egil Matsen, 2006. "Portfolio Choice when Managers Control Returns," Working Paper Series 6606, Department of Economics, Norwegian University of Science and Technology.
    2. Mehmet Barlo & Ayça Özdoğan, 2013. "The Optimality of Team Contracts," Games, MDPI, Open Access Journal, vol. 4(4), pages 670-689, November.

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