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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 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, giving the principal an incentive to reduce the continuation value of the project. 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-rr.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 1726RR.

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    Length: 141 pages
    Date of creation: Sep 2009
    Date of revision: Mar 2013
    Handle: RePEc:cwl:cwldpp:1726rr

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    Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

    Related research

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

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    References

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    1. Steven N. Kaplan & Per Stromberg, 2000. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," NBER Working Papers 7660, National Bureau of Economic Research, Inc.
    2. Keller, Godfrey & Rady, Sven, 2009. "Strategic Experimentation with Poisson Bandits," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 260, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    3. Boyan Jovanovic & Balàzs Szentes, 2007. "On the Return to Venture Capital," NBER Working Papers 12874, National Bureau of Economic Research, Inc.
    4. Peeters, Carine & Pottelsberghe de la Potterie, Bruno van, 2003. "Measuring Innovation Competencies and Performances: A Survey of Large Firms in Belgium," IIR Working Paper 03-16, Institute of Innovation Research, Hitotsubashi University.
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    6. Rothschild, Michael, 1974. "A two-armed bandit theory of market pricing," Journal of Economic Theory, Elsevier, vol. 9(2), pages 185-202, October.
    7. Steven N. Kaplan & Per Str�mberg, 2003. "Financial Contracting Theory Meets the Real World: An Empirical Analysis of Venture Capital Contracts," Review of Economic Studies, Oxford University Press, vol. 70(2), pages 281-315.
    8. 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.
    9. Paul Gompers & Josh Lerner, 2001. "The Venture Capital Revolution," Journal of Economic Perspectives, American Economic Association, vol. 15(2), pages 145-168, Spring.
    10. Biais, Bruno & Mariotti, Thomas & Plantin, Guillaume & Rochet, Jean Charles, 2004. "Dynamic Security Design," CEPR Discussion Papers 4753, C.E.P.R. Discussion Papers.
    11. Denis, Diane K. & Shome, Dilip K., 2005. "An empirical investigation of corporate asset downsizing," Journal of Corporate Finance, Elsevier, vol. 11(3), pages 427-448, June.
    12. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, December.
    13. Patrick Bolton & Christopher Harris, 1999. "Strategic Experimentation," Econometrica, Econometric Society, vol. 67(2), pages 349-374, March.
    14. Asher Blass & Oved Yosha, 2003. "Financing R&D in mature companies: An empirical analysis," Economics of Innovation and New Technology, Taylor & Francis Journals, vol. 12(5), pages 425-447.
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    Cited by:
    1. Terstiege, Stefan, 2014. "Private versus verifiable interim performance evaluations under uncertainty," Economics Letters, Elsevier, vol. 123(3), pages 341-344.

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