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Is there a Golden Parachute in Sannikov's principal-agent problem?

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  • Dylan Possamai
  • Nizar Touzi

Abstract

This paper provides a complete review of the continuous-time optimal contracting problem introduced by Sannikov, in the extended context allowing for possibly different discount rates for both parties. The agent's problem is to seek for optimal effort, given the compensation scheme proposed by the principal over a random horizon. Then, given the optimal agent's response, the principal determines the best compensation scheme in terms of running payment, retirement, and lump-sum payment at retirement. A Golden Parachute is a situation where the agent ceases any effort at some positive stopping time, and receives a payment afterwards, possibly under the form of a lump sum payment, or of a continuous stream of payments. We show that a Golden Parachute only exists in certain specific circumstances. This is in contrast with the results claimed by Sannikov, where the only requirement is a positive agent's marginal cost of effort at zero. Namely, we show that there is no Golden Parachute if this parameter is too large. Similarly, in the context of a concave marginal utility, there is no Golden Parachute if the agent's utility function has a too negative curvature at zero. In the general case, we prove that an agent with positive reservation utility is either never retired by the principal, or retired above some given threshold (as in Sannikov's solution). We show that different discount factors induce a face-lifted utility function, which allows to reduce the analysis to a setting similar to the equal discount rates one. Finally, we also confirm that an agent with small reservation utility may have an informational rent, meaning that the principal optimally offers him a contract with strictly higher utility than his participation value.

Suggested Citation

  • Dylan Possamai & Nizar Touzi, 2020. "Is there a Golden Parachute in Sannikov's principal-agent problem?," Papers 2007.05529, arXiv.org, revised Oct 2022.
  • Handle: RePEc:arx:papers:2007.05529
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    References listed on IDEAS

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    Cited by:

    1. Martin Dumav, 2021. "Moral Hazard, Dynamic Incentives, and Ambiguous Perceptions," Papers 2110.15229, arXiv.org.

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