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

Hellwig, Martin F. and Schmidt, Klaus M. (July 2001): Discrete-Time Approximations of the Holmström-Milgrom Brownian-Motion Model of Intertemporal Incentive Provision. Discussion Papers in Economics 2001-11

Abstract

This paper studies the relation between discrete-time and continuoustime principal-agent models. We derive the continuous-time model as a limit of discretetime models with ever shorter periods and show that optimal incentive schemes in the discrete-time models approximate the optimal incentive scheme in the continuous model, which is linear in accounts. Under the additional assumption that the principal observes only cumulative total profits at the end and the agent can destroy profits unnoticed, an incentive scheme that is linear in total profits is shown to be approximately optimal in the discrete-time model when the length of the period is small.

• Item Type: Paper (Discussion Paper)
• Keywords: Principal-agent problems ; linear incentive schemes ; intertemporal incentive provision ; Brownian motion
• Subjects: Economics; Economics > Discussion Papers in Economics; Economics > Discussion Papers in Economics > Micro-Economics; Economics > Discussion Papers in Economics > Industrial Organization; Economics > Discussion Papers in Economics > Economics of Information
• Dewey Classification: 300 Social sciences; 300 Social sciences > 330 Wirtschaft
• Journal of Economic Literature classification: C61, D82, J33
• Language: English