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Pareto Frontier of a Dynamic Principal–Agent Model with Discrete Actions: An Evolutionary Multi-Objective Approach

Author

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  • Itza Curiel
  • Sonia Di Giannatale

    ()

  • Juan Herrera
  • Katya Rodríguez

Abstract

In this article, a dynamic Principal–Agent model with discrete actions is analysed from a Multi-Objective optimization framework. As a result, a concave Pareto Frontier is numerically approximated. The concavity of the Pareto Frontier is a consequence of the information asymmetry between the Principal and the Agent. The underlying Multi-Objective framework allows us to consider more powerful assumptions than those used in the traditional Single-Objective optimization approach. As contracts move in the Pareto Frontier (trade-off surface) towards those that are more advantageous to the Agent, the prevalence of compensation plans in which the Principal assumes most of the risk of the productive activity are observed. When the Principal and the Agent are more patient, both obtain higher values of their discounted expected utilities, which generates a higher level of economic surplus. The Agent faces lower variability in future compensation when it is costlier for him to exert an additional effort unit. Finally, a new Multi-Objective Evolutionary Algorithm (MOEA) is proposed in this article to approximate Pareto Frontiers, such algorithm involves an innovative ranking-mutation mechanism which promotes approximations with good spread, achieving even better results that some obtained by already well known MOEAs. Copyright Springer Science+Business Media, LLC. 2012

Suggested Citation

  • Itza Curiel & Sonia Di Giannatale & Juan Herrera & Katya Rodríguez, 2012. "Pareto Frontier of a Dynamic Principal–Agent Model with Discrete Actions: An Evolutionary Multi-Objective Approach," Computational Economics, Springer;Society for Computational Economics, vol. 40(4), pages 415-443, December.
  • Handle: RePEc:kap:compec:v:40:y:2012:i:4:p:415-443
    DOI: 10.1007/s10614-011-9307-6
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    References listed on IDEAS

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    1. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, vol. 50(1), pages 97-109, January.
    2. Stephen E. Spear & Sanjay Srivastava, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Oxford University Press, vol. 54(4), pages 599-617.
    3. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    4. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    5. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
    6. Dominique Demougin & Carsten Helm, 2006. "Moral Hazard and Bargaining Power," German Economic Review, Verein für Socialpolitik, vol. 7, pages 463-470, November.
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    Cited by:

    1. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    2. Sonia Di Giannatale & Itza Curiel & Juan Herrera & Katya Rodríguez, 2012. "Productivity Shocks, Discount Rate and Incentives," Working papers DTE 531, CIDE, División de Economía.

    More about this item

    Keywords

    Asymmetric information; Principal–Agent model; Incentives; Pareto Frontier; Evolutionary Algorithms; C63; D61; D82; D86; L14;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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