Randomization in dynamic principal-agent problems

Müller, Holger M.

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URL: https://ub-madoc.bib.uni-mannheim.de/2888
URN: urn:nbn:de:bsz:180-madoc-28884
Document Type: Working paper
Year of publication: 1997
The title of a journal, publication series: Rationalitätskonzepte, Entscheidungsverhalten und ökonomische Modellierung
Volume: 97-37
Place of publication: Mannheim
Publication language: English
Institution: School of Law and Economics > Sonstige - Fakultät für Rechtswissenschaft und Volkswirtschaftslehre
MADOC publication series: Sonderforschungsbereich 504 > Rationalitätskonzepte, Entscheidungsverhalten und ökonomische Modellierung (Laufzeit 1997 - 2008)
Subject: 330 Economics
Subject headings (SWD): Agency-Theorie , Anreizsystem , Wahrscheinlichkeitsrechnung , Theorie
Abstract: In a seminal paper, Holmström and Milgrom (1987) examine a principal-agent problem in which an agent controls the drift of a Brownian motion. Given that the agent can revise his control continuously, they show that the optimal sharing rule is linear in aggregated output. In this paper, we examine the case where control revisions take place in arbitrarily small discrete time intervals. We show that the first-best outcome can be approached arbitrarily closely by a random spot check in conjunction with a step function. The central message of this paper is therefore that in agency problems of the sort studied by Holmström and Milgrom, linear sharing rules may not always be optimal. Random spot checks are widely used in practice and play an important role in the area of quality control.
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