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

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  • Hellwig, Martin

    ()
    (Sonderforschungsbereich 504)

  • Schmidt, Klaus M.

    ()
    (Universität München)

Abstract

This paper studies the relation between multi-period discrete-time and continuous-time principal-agent models. We explicitly derive the continuous-time model as a limit of discrete-time models with ever shorter periods and show that the optimal incentive scheme in the continuous model, which is linear in accounts, can be approximated by a sequence of optimal incentive schemes in the discrete models. For a variant of the discrete-time model in which the principal observes only total profits at the end of the last period and where the agent can destroy profits unnoticed we show, that if the length of each period is sufficiently small, then an incentive scheme that is linear in total profits is approximately optimal.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 98-06.

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Length: 58 pages
Date of creation: 07 May 1998
Date of revision:
Handle: RePEc:xrs:sfbmaa:98-06

Note: For helpful comments and discussions we are grateful to Darell Duffie, Oliver Hart, Bengt Holmström, Nobuhiro Kiyotaki, John Moore, Holger Müller, Sven Rady, and Jae Sung. We are also grateful for research support from the Schweizerischer Nationalfonds, the Deutsche Forschungsgemeinschaft, and the Taussig Chair at Harvard University.
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References

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  1. 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.
  2. Martin F. Hellwig & Klaus M. Schmidt, 2002. "Discrete-Time Approximations of the Holmstrom-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision," Econometrica, Econometric Society, Econometric Society, vol. 70(6), pages 2225-2264, November.
  3. Hellwig, Martin F., 1996. "Sequential decisions under uncertainty and the maximum theorem," Journal of Mathematical Economics, Elsevier, vol. 25(4), pages 443-464.
  4. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
  5. Mirrlees, J A, 1999. "The Theory of Moral Hazard and Unobservable Behaviour: Part I," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 3-21, January.
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Cited by:
  1. Dietl, Helmut M. & Grossmann, Martin & Lang, Markus & Wey, Simon, 2013. "Incentive effects of bonus taxes in a principal-agent model," Journal of Economic Behavior & Organization, Elsevier, vol. 89(C), pages 93-104.
  2. Guo, Ming & Ou-Yang, Hui, 2006. "Incentives and performance in the presence of wealth effects and endogenous risk," Journal of Economic Theory, Elsevier, vol. 129(1), pages 150-191, July.
  3. Drew Fudenberg & David K Levine, 2007. "Repeated Games with Frequent Signals," Levine's Working Paper Archive 814577000000000009, David K. Levine.
  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. Fehr, Ernst & Schmidt, Klaus M., 2004. "Fairness and Incentives in a Multi-Task Principal-Agent Model," Discussion Papers in Economics 335, University of Munich, Department of Economics.
  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. Hellwig, Martin & Schmidt, Klaus M., 1998. "Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion, Model of Intertemporal Incentive Provision," Sonderforschungsbereich 504 Publications, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim 98-06, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  8. James Mirrlees & Roberto Raimondo, 2013. "Strategies in the principal-agent model," Economic Theory, Springer, Springer, vol. 53(3), pages 605-656, August.
  9. Giat, Yahel & Subramanian, Ajay, 2013. "Dynamic contracting under imperfect public information and asymmetric beliefs," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(12), pages 2833-2861.
  10. Barlo, Mehmet & Ayca, Ozdogan, 2012. "Team beats collusion," MPRA Paper 37449, University Library of Munich, Germany.
  11. 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, Elsevier, vol. 50(2-3), pages 179-234, December.

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