By Günter Bamberg, Klaus Spremann (auth.), Prof. Dr. Günter Bamberg, Prof. Dr. Klaus Spremann (eds.)
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Extra info for Agency Theory, Information, and Incentives
Following the agency literature we assume that the manager market is perfectly competitive which implies G = O. The market entry and exit of managers drive the long run income and the associated certainty equivalent down to zero. The optimal amount of F turns out to be negative which means that the side payment goes from managers to owners.
Agent and principal just speak on payment schemes p and none of them has doubts about the corresponding effort induced. Since they do not settle effort, there is no shirking. The discussion between agent and principal on the payment scheme was modelled here in that way: The principal selects, from all 17 payment schemes which guarantee the agent a certain welfare U ~ that scheme Pm* which maximizes her own welfare V. 4. 3 The LEN-Model The hidden-effort situation as outlined in the last section cannot be solved in its general form.
The principal wants to choose a reward scheme given by the triple (r,s,t) such that her welfare, the expected resiudal wealth y - (r + sy + tz), is maximized. ,X,c,m and can thus predict the agent's response x* = ~(r,s,t) to a reward scheme (r,s,t). The agent's wealth, similar to (10), is normally distributed, (30 ) w(x;r,s,t) r + s(x + 8) + t(x + £) - x and the welfare (certainty equivalent) is equal to ( 31) U(x;r,s,t) r + (s + t)x - x 2 2 28 Maximization of (31) with respect to x yields (32 ) x* s + t -2- ~(r,s,t) which is the induced effort.