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What Can We Learn From Simulating a Standard Agency Model?

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  • Michel Robe

    () (American University)

Abstract

For typical parametrizations of the standard Holmstrom (1979) agency model, this paper demonstrates that the set of first-order conditions characterizing the optimal contract can be reduced to a single equation. A problem of investment financing under moral hazard is used to illustrate the reduced-form equation's usefulness in quantitative applications. When the agent has CARA preferences over consumption, it is shown that any exogenous limit on the penalties for low output is always binding.

Suggested Citation

  • Michel Robe, 2001. "What Can We Learn From Simulating a Standard Agency Model?," Computing in Economics and Finance 2001 98, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:98
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    References listed on IDEAS

    as
    1. Robe, Michel A., 1999. "Optimal vs. Traditional Securities under Moral Hazard," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(02), pages 161-189, June.
    2. 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.
    3. Faynzilberg, Peter S. & Kumar, Praveen, 1997. "Optimal Contracting of Separable Production Technologies," Games and Economic Behavior, Elsevier, vol. 21(1-2), pages 15-39, October.
    4. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
    5. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-276, April.
    6. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-1190, September.
    7. Mirrlees, James A, 1997. "Information and Incentives: The Economics of Carrots and Sticks," Economic Journal, Royal Economic Society, vol. 107(444), pages 1311-1329, September.
    8. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer.
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    Cited by:

    1. Calcagno, R. & Renneboog, L.D.R., 2004. "Capital Structure and Managerial Compensation : The Effects of Remuneration Seniority," Discussion Paper 2004-015, Tilburg University, Tilburg Law and Economic Center.
    2. Zsuzsanna Fluck & Kedran Garrison & Stewart C. Myers, 2005. "Venture Capital Contracting and Syndication: An Experiment in Computational Corporate Finance," NBER Working Papers 11624, National Bureau of Economic Research, Inc.
    3. Olmos, Marta Fernandez & Martinez, Jorge Rosell, 2010. "The Quality-Quantity Trade-off in the Principal-Agent Framework," Agricultural Economics Review, Greek Association of Agricultural Economists, vol. 11(1), January.
    4. Olmos, Marta Fernandez & Rosell-Martinez, Jorge & Espitia-Escuer, Manuel Antonio, 2008. "The yield/quality trade-off and contractual choice," 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida 6065, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).

    More about this item

    Keywords

    Moral Hazard; Numerical Analysis; Reduced-Form Equation; Limited Liability.;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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