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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26850
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| Title: | Optimal Retention in Principal/Agent Models |
| Authors: | Banks, Jeffrey S.
Sundaram, Rangarajan K. |
| Issue Date: | 2-Feb-1998 |
| Series/Report no.: | FIN-98-006 |
| Abstract: | This paper studies the interaction between a single long-lived principal
and a series of short-lived agents in the presence of both moral hazard
and adverse selection. We assume that the principal can influence the
agents' behavior only through her choice of a retention rule; this rule
is further required to be sequentially rational (i.e., no precommitment
is allowed). We provide general conditions under which equilibria exist
in which (a) the principal adopts a 'cut-off' rule under which agents
are retained only when the reward they generate exceeds a critical
bound; and (b) agent separate according to type, with better agents
taking superior actions. We show that in equilibrium, a retained agent's
productivity is necessarily declining over time, but that retained
agents are also more productive on average than untried agents due to
selection effects. Finally, we show that for each given type, agents of
that type are more productive in the presence of adverse selection than
when there is pure moral hazard (i.e., when that type is the sole type
of agent in the model); nonetheless, adding uncertainty about
agent-types cannot benefit the principal except in uninteresting cases. |
| URI: | http://hdl.handle.net/2451/26850 |
| Appears in Collections: | Economics Working Papers
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