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Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision

Author

Listed:
  • Hellwig, Martin

    (Sonderforschungsbereich 504)

  • Schmidt, Klaus M.

    (Universität München)

Abstract

This paper studies the relation between discrete-time and continuous-time principal-agent models. We derive the continuous-time model as a limit of discrete-time models with ever shorter periods and show that optimal incentive schemes in the discrete-time models approximate the optimal incentive scheme in the continuous model, which is linear in accounts. Under the additional assumption that the principal observes only cumulative total profits at the end and the agent can destroy profits unnoticed, an incentive scheme that is linear in total profits is shown to be approximately optimal in the discrete-time model when the length of the period is small.

Suggested Citation

  • Hellwig, Martin & Schmidt, Klaus M., 2001. "Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision," Sonderforschungsbereich 504 Publications 01-52, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    • Handle: RePEc:xrs:sfbmaa:01-52
    Note: For helpful comments and discussions we are grateful to Darell Duffie, Oliver Hart, Florian Herold, Bengt Holmström, Nobuhiro Kiyotaki, Paul Milgrom, John Moore, Holger Müller, Sven Rady, Jae Sung, three anonymous referees and the editor, Drew Fudenberg. The first author gratefully acknowledges research support from the Schweizerischer Nationalfonds, the Deutsche Forschungsgemeinschaft, and the Taussig Chair at Harvard University. The second author is grateful for research support from the Deutsche Forschungsgemeinschaft through grants SCHM1196/2-1 and /4-1 and for the hospitality enjoyed at the economics department of Stanford University.Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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