Timing of Effort and Reward: Three-Sided Moral Hazard in a Continuous-Time Model
This paper studies a three-sided moral hazard problem with one agent exerting up-front effort and two agents exerting ongoing effort in a continuous-time model. The agents' efforts jointly affect the probability of survival and thus the expected cash flow of the project. In the optimal contract, the timing of payments reflects the timing of effort: payments for up-front effort precede payments for ongoing effort. Several patterns are possible for the cash allocation between the two agents with ongoing effort. In one case, where the two agents face equally severe moral hazard, they share the cash flow equally at each point of time. In another case, where the two agents have different severities of moral hazard, their payments are sequential. In a more general case, the two agents with ongoing effort first receive the cash flow alternately with an increasing frequency of switches and then divide the cash flow at each point of time. This study provides a framework for understanding a broad set of business-contracting issues. The characteristics suggested in the optimal contract help us analyze the causes of business failure such as the recent debacle of mortgage-backed securities.
Volume (Year): 56 (2010)
Issue (Month): 9 (September)
|Contact details of provider:|| Postal: 7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA|
Web page: http://www.informs.org/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Weinstein, Mark, 1998. "Profit-Sharing Contracts in Hollywood: Evolution and Analysis," The Journal of Legal Studies, University of Chicago Press, vol. 27(1), pages 67-112, January.
- Catherine Casamatta, 2003.
"Financing and Advising: Optimal Financial Contracts with Venture Capitalists,"
Journal of Finance,
American Finance Association, vol. 58(5), pages 2059-2086, October.
- Casamatta, Catherine, 2002. "Financing and Advising: Optimal Financial Contracts with Venture Capitalists," CEPR Discussion Papers 3475, C.E.P.R. Discussion Papers.
- Admati, Anat R & Pfleiderer, Paul, 1994. " Robust Financial Contracting and the Role of Venture Capitalists," Journal of Finance, American Finance Association, vol. 49(2), pages 371-402, June.
- Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
- Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
- Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
- Alex Edmans & Xavier Gabaix & Tomasz Sadzik & Yuliy Sannikov, 2009. "Dynamic Incentive Accounts," NBER Working Papers 15324, National Bureau of Economic Research, Inc.
- Edmans, Alex & Gabaix, Xavier & Sadzik, Tomasz & Sannikov, Yuliy, 2009. "Dynamic Incentive Accounts," CEPR Discussion Papers 7497, C.E.P.R. Discussion Papers.
- Yuliy Sannikov & Xavier Gabaix & Tomasz Sadzik & Alex Edmans, 2010. "Dynamic Incentive Accounts," 2010 Meeting Papers 1207, Society for Economic Dynamics.
- Edmans, Alex & Gabaix, Xavier & Sadzik, Tomasz & Sannikov, Yuliy, 2010. "Dynamic Incentive Accounts," Working Papers 10-19, University of Pennsylvania, Wharton School, Weiss Center.
- Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, vol. 63(2), pages 134-139, May.
- Philip H. Dybvig & Nancy A. Lutz, 1993. "Warranties, Durability, and Maintenance: Two-sided Moral Hazard in a Continuous-Time Model," Review of Economic Studies, Oxford University Press, vol. 60(3), pages 575-597.
- Nancy A. Lutz & Philip H. Dybvig, 1989. "Warranties, Durability, and Maintenance: Two Sided Moral Hazard in a Continuous-Time Model," Cowles Foundation Discussion Papers 922, Cowles Foundation for Research in Economics, Yale University.
- Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
- PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
- Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-1284, December.
- Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
- 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.
- Chisholm, Darlene C, 1997. "Profit-Sharing versus Fixed-Payment Contracts: Evidence from the Motion Pictures Industry," Journal of Law, Economics and Organization, Oxford University Press, vol. 13(1), pages 169-201, April.
- Jaeyoung Sung, 1995. "Linearity with Project Selection and Controllable Diffusion Rate in Continuous-Time Principal-Agent Problems," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 720-743, Winter.
- Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 173-208. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:56:y:2010:i:9:p:1568-1583. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.