What Can We Learn from Simulating a Standard Agency Model?
Posted: 7 Jan 2002
Abstract
For typical parameterizations of the standard Holmstrom [Bell Journal of Economics 10 (1979) 74] 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.
Keywords: Moral Hazard, Numerical Analysis, Reduced-Form Equation, Limited Liability, Performance target
JEL Classification: D82, C50, C61, C63
Suggested Citation: Suggested Citation