Numerical Analysis of a Dynamic Model of Agency

27 Pages Posted: 6 Oct 2009

Date Written: July 2005

Abstract

This paper considers an infinite-horizon principal-agent model with moral hazard. Following the insights of Grossman and Hart (1983) and the methodology of recursive contracts we are able to establish properties of the optimal dynamic contract analytically. We solve the contracting problem numerically, simulate the long-run distributions of discounted utility (the state variable) for different initial conditions, and calculate the moments of the policy functions. This allows us to further our understanding of the trade-offs between current and deferred compensation in the provision of incentives. Furthermore, since we can obtain first-order conditions for the principal’s optimization problem, we assess the accuracy of numerical solutions using the first-order conditions’ residuals. Finally, we compute the cost-minimizing contracts under different contractual arrangements and calculate the corresponding effects on the surplus of the principal and of the agent.

Suggested Citation

Aseff, Jorge G., Numerical Analysis of a Dynamic Model of Agency (July 2005). Available at SSRN: https://ssrn.com/abstract=1483430 or http://dx.doi.org/10.2139/ssrn.1483430

Jorge G. Aseff (Contact Author)

Brown Brothers Harriman ( email )

140 Broadway
New York, NY 10005
United States