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A Continuous-Time Version of the Principal-Agent Problem

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  • Yuliy Sannikov

Abstract

This paper describes a new continuous-time principal-agent model, in which the output is a diffusion process with drift determined by the agent's unobserved effort. The risk-averse agent receives consumption continuously. The optimal contract, based on the agent's continuation value as a state variable, is computed by a new method using a differential equation. During employment, the output path stochastically drives the agent's continuation value until it reaches a point that triggers retirement, quitting, replacement, or promotion. The paper explores how the dynamics of the agent's wages and effort, as well as the optimal mix of short-term and long-term incentives, depend on the contractual environment. Copyright 2008, Wiley-Blackwell.

Suggested Citation

  • Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(3), pages 957-984.
    • Handle: RePEc:oup:restud:v:75:y:2008:i:3:p:957-984
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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2008.00486.x
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