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Principal-Agent Problems with Exit Options

Author

Listed:
  • Cvitanic Jaksa

    () (Caltech)

  • Wan Xuhu

    () (Hong Kong University of Science and Technology)

  • Zhang Jianfeng

    () (University of Southern California)

Abstract

We consider the problem of when to deliver the contract payoff, in a continuous-time principal-agent setting, in which the agent's effort is unobservable. The principal can design contracts of a simple form that induce the agent to ask for the payoff at the time of the principal's choosing. The optimal time of payment depends on the agent's and the principal's outside options. We develop a theory for general utility functions, while with CARA utilities we are able to specify conditions under which the optimal payment time is not random. However, in general, the optimal payment time is typically random. One illustrative application is the case when the agent can be fired, after having been paid a severance payment, and then replaced by another agent. The methodology we use is the stochastic maximum principle and its link to Forward-Backward Stochastic Differential Equations.

Suggested Citation

  • Cvitanic Jaksa & Wan Xuhu & Zhang Jianfeng, 2008. "Principal-Agent Problems with Exit Options," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 8(1), pages 1-43, October.
  • Handle: RePEc:bpj:bejtec:v:8:y:2008:i:1:n:23
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    References listed on IDEAS

    as
    1. Jaeyoung Sung, 2005. "Optimal Contracts Under Adverse Selection and Moral Hazard: A Continuous-Time Approach," Review of Financial Studies, Society for Financial Studies, pages 1021-1073.
    2. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, January.
    3. Muller, Holger M., 1998. "The First-Best Sharing Rule in the Continuous-Time Principal-Agent Problem with Exponential Utility," Journal of Economic Theory, Elsevier, vol. 79(2), pages 276-280, April.
    4. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474, June.
    5. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, pages 303-328.
    6. Muller, Holger M., 2000. "Asymptotic Efficiency in Dynamic Principal-Agent Problems," Journal of Economic Theory, Elsevier, vol. 91(2), pages 292-301, April.
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    Cited by:

    1. Zhang, Yuzhe, 2009. "Dynamic contracting with persistent shocks," Journal of Economic Theory, Elsevier, vol. 144(2), pages 635-675, March.
    2. Mohamed Belhaj & Nataliya Klimenko, 2012. "Optimal Preventive Bank Supervision Combining Random Audits and Continuous Intervention," AMSE Working Papers 1201, Aix-Marseille School of Economics, Marseille, France.
    3. Patrick Bolton & Christopher Harris, 2005. "The Dynamics of Optimal Risk Sharing," Economics Working Papers 0092, Institute for Advanced Study, School of Social Science, revised May 2010.
    4. Barlo, Mehmet & Özdog˜an, Ayça, 2014. "Optimality of linearity with collusion and renegotiation," Mathematical Social Sciences, Elsevier, vol. 71(C), pages 46-52.
    5. Cuoco, Domenico & Kaniel, Ron, 2011. "Equilibrium prices in the presence of delegated portfolio management," Journal of Financial Economics, Elsevier, pages 264-296.
    6. Peter M. DeMarzo & Yuliy Sannikov, 2004. "A Continuous-Time Agency Model of Optimal Contracting and Capital Structure," NBER Working Papers 10615, National Bureau of Economic Research, Inc.
    7. Cvitanic, Jaksa & Radas, Sonja & Sikic, Hrvoje, 2011. "Co-development ventures: Optimal time of entry and profit-sharing," Journal of Economic Dynamics and Control, Elsevier, vol. 35(10), pages 1710-1730, October.

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