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Wealth-Robust Intertemporal Incentive Contracts

Author

Listed:
  • Mark Loewenstein
  • Jerome Detemple

    (Rutgers Business School RutgersUniversity)

  • Suresh Govindaraj

Abstract

We study optimal incentive contracts in a continuous time principal-agent setting with hidden actions. The agent, whose effort controls the output, has a concave utility function which is non-separable in wealth and monetary cost of effort. The principal is risk neutral and optimally selects the effort to be induced and the contract design. Output follows a mean-reverting process with random coefficients. We characterize the class of W-robust compensation schemes that elicit a desired effort which is immune to the principal's mispecifications of the future wealth of the manager. We demonstrate the existence of a solution to the principal's problem, characterize the optimal effort policy, derive the optimal W-robust contract and show that our contract dominates randomized contracts

Suggested Citation

  • Mark Loewenstein & Jerome Detemple & Suresh Govindaraj, 2005. "Wealth-Robust Intertemporal Incentive Contracts," Computing in Economics and Finance 2005 171, Society for Computational Economics.
    • Handle: RePEc:sce:scecf5:171
    as

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    More about this item

    Keywords

    Hidden Actions; Intertemporal Contracts; Principal-Agent; Wealth Robust Contracts.;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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