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

  • Hellwig, Martin

    ()

    (Sonderforschungsbereich 504)

  • Schmidt, Klaus M.

    ()

    (Universität München)

This paper studies the relation between multi-period discrete-time and continuous-time principal-agent models. We explicitly derive the continuous-time model as a limit of discrete-time models with ever shorter periods and show that the optimal incentive scheme in the continuous model, which is linear in accounts, can be approximated by a sequence of optimal incentive schemes in the discrete models. For a variant of the discrete-time model in which the principal observes only total profits at the end of the last period and where the agent can destroy profits unnoticed we show, that if the length of each period is sufficiently small, then an incentive scheme that is linear in total profits is approximately optimal.

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Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 98-06.

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Length: 58 pages
Date of creation: 07 May 1998
Date of revision:
Handle: RePEc:xrs:sfbmaa:98-06
Note: For helpful comments and discussions we are grateful to Darell Duffie, Oliver Hart, Bengt Holmström, Nobuhiro Kiyotaki, John Moore, Holger Müller, Sven Rady, and Jae Sung. We are also grateful for research support from the Schweizerischer Nationalfonds, the Deutsche Forschungsgemeinschaft, and the Taussig Chair at Harvard University.
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