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Incentives for Experimenting Agents

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    Abstract

    We examine a repeated interaction between an agent, who undertakes experiments, and a principal who provides the requisite funding for these experiments. The agent’s actions are hidden, and the principal cannot commit to future actions. The repeated interaction gives rise to a dynamic agency cost -- the more lucrative is the agent’s stream of future rents following a failure, the more costly are current incentives for the agent. As a result, the principal may deliberately delay experimental funding, reducing the continuation value of the project and hence the agent’s current incentive costs. We characterize the set of recursive Markov equilibria. We also find that there are non-Markov equilibria that make the principal better off than the recursive Markov equilibrium, and that may make both agents better off. Efficient equilibria front-load the agent’s effort, inducing as much experimentation as possible over an initial period, until making a switch to the worst possible continuation equilibrium. The initial phase concentrates the agent’s effort near the beginning of the project, where it is most valuable, while the eventual switch to the worst continuation equilibrium attenuates the dynamic agency cost.

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    File URL: http://cowles.econ.yale.edu/P/cd/d17a/d1726-r.pdf
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    Bibliographic Info

    Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1726R.

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    Length: 141 pages
    Date of creation: Sep 2009
    Date of revision: Feb 2012
    Handle: RePEc:cwl:cwldpp:1726r

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    Web page: http://cowles.econ.yale.edu/
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    Related research

    Keywords: Experimentation; Learning; Agency; Dynamic agency; Venture capital; Repeated principal-agent problem;

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    References

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    1. Dirk Bergemann & Ulrich Hege & Liang Peng, 2009. "Venture Capital and Sequential Investments," Levine's Working Paper Archive 814577000000000046, David K. Levine.
    2. Carine Peeters & Bruno Van Pottelsberghe, 2003. "Measuring innovation competencies and performances: a survey of large firms in Belgium," Working Papers CEB 04-005.RS, ULB -- Universite Libre de Bruxelles.
    3. Matthias Doepke & Robert M. Townsend, 2002. "Dynamic Mechanism Design With Hidden Income and Hidden Actions," UCLA Economics Working Papers 818, UCLA Department of Economics.
    4. Perry Motty & Reny Philip J., 1993. "A Non-cooperative Bargaining Model with Strategically Timed Offers," Journal of Economic Theory, Elsevier, vol. 59(1), pages 50-77, February.
    5. Simon, Leo K. & Stinchcombe, Maxwell B., 1987. "Extensive From Games in Continuous Time: Pure Strategies," Department of Economics, Working Paper Series qt03x115sh, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    6. Asher Blass & Oved Yosha, 2003. "Financing R&D in mature companies: An empirical analysis," Economics of Innovation and New Technology, Taylor and Francis Journals, vol. 12(5), pages 425-447.
    7. Bergin, James & MacLeod, W Bentley, 1993. "Continuous Time Repeated Games," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(1), pages 21-37, February.
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