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Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision

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  • Hellwig, Martin F.
  • Schmidt, Klaus M.

Abstract

This paper studies the relation between discrete-time and continuoustime principal-agent models. We derive the continuous-time model as a limit of discretetime models with ever shorter periods and show that optimal incentive schemes in the discrete-time models approximate the optimal incentive scheme in the continuous model, which is linear in accounts. Under the additional assumption that the principal observes only cumulative total profits at the end and the agent can destroy profits unnoticed, an incentive scheme that is linear in total profits is shown to be approximately optimal in the discrete-time model when the length of the period is small.

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Bibliographic Info

Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 22.

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Date of creation: Jul 2001
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Handle: RePEc:lmu:muenec:22

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Keywords: Principal-agent problems ; linear incentive schemes ; intertemporal incentive provision ; Brownian motion;

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  1. Hellwig, Martin F. & Schmidt, Klaus M., 2001. "Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision," Discussion Papers in Economics 22, University of Munich, Department of Economics.
  2. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 3-21, January.
  3. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
  4. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
  5. Hellwig, Martin F., 1996. "Sequential decisions under uncertainty and the maximum theorem," Journal of Mathematical Economics, Elsevier, vol. 25(4), pages 443-464.
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Citations

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Cited by:
  1. Ernst Fehr & Klaus M. Schmidt, . "Fairness and Incentives in a Multi-Task Principal-Agent Model," IEW - Working Papers 191, Institute for Empirical Research in Economics - University of Zurich.
  2. Hellwig, Martin & Schmidt, Klaus M., 2001. "Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision," Sonderforschungsbereich 504 Publications 01-52, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
  3. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.
  4. Drew Fudenberg & David Levine, 2007. "Continuous Time Limits of Repeated Games with Imperfect Public Monitoring," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 10(2), pages 173-192, April.
  5. Barlo, Mehmet & Ayca, Ozdogan, 2012. "Team beats collusion," MPRA Paper 37449, University Library of Munich, Germany.
  6. Coles, Jeffrey & Lemmon, Michael & Meschke, Felix, 2007. "Structural Models and Endogeneity in Corporate Finance: the Link Between Managerial Ownership and Corporate Performance," MPRA Paper 4374, University Library of Munich, Germany, revised 15 Feb 2007.
  7. Drew Fudenberg & David K Levine, 2007. "Repeated Games with Frequent Signals," Levine's Working Paper Archive 814577000000000009, David K. Levine.

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