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Compromises and Incentives

Author

Listed:
  • Sonia Di Giannatale Menegalli

    () (Division of Economics, CIDE)

  • Itza T. Q. Curiel-Cabral

Abstract

We analyze a situation where a Principal does not necessarily have all the bargaining power while negotiating a contract with an Agent by studying a dynamic multi-objective moral hazard model with hidden action. We .nd that the structure of the optimal contracts change along the Pareto Frontier, and that compromise solutions implement higher Agent.s e¤ort levels when compared to contracts located at the Pareto Frontier.s extremes. Our numerical results indicate that in compromise solutions, compared to the contracts located at the Pareto Frontier.s extremes, the Agent exerts higher e¤ort levels, the Agent.s future compensation schedules show higher spread, and the Agent.s salaries become more directly related to productivity outcomes as time goes on. When the coe¢ cient of relative risk aversion increases, compromise solutions tend to become closer to the Agent.s most advan-tageous contract. Improvements in the .rm.s productivity environment bene.t, in relative terms, the Agent more than the Principal when compromise solutions are implemented.

Suggested Citation

  • Sonia Di Giannatale Menegalli & Itza T. Q. Curiel-Cabral, 2013. "Compromises and Incentives," Working papers DTE 559, CIDE, División de Economía.
  • Handle: RePEc:emc:wpaper:dte559
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    File URL: http://cide.edu/repec/economia/pdf/DTE/DTE559.pdf
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    References listed on IDEAS

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    3. Gian Luca Clementi & Thomas Cooley & Sonia Di Giannatale, 2010. "A Theory of Firm Decline," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(4), pages 861-885, October.
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    5. 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.
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    8. George-Levi Gayle & Robert A. Miller, 2009. "Has Moral Hazard Become a More Important Factor in Managerial Compensation?," American Economic Review, American Economic Association, vol. 99(5), pages 1740-1769, December.
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    More about this item

    Keywords

    Asymmetric information; Principal-Agent Model; Incentives; Pareto Frontier; Compromise Solutions; Multi-Objective Problems; Evolutionary Algorithms;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • C78 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Bargaining Theory; Matching Theory
    • 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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