Optimal compensation with adverse selection and dynamic actions
 Jakša Cvitanić,
 Jianfeng Zhang
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We consider continuoustime models in which the agent is paid at the end of the time horizon by the principal, who does not know the agent’s type. The agent dynamically affects either the drift of the underlying output process, or its volatility. The principal’s problem reduces to a calculus of variation problem for the agent’s level of utility. The optimal ratio of marginal utilities is random, via dependence on the underlying output process. When the agent affects the drift only, in the risk neutral case lower volatility corresponds to the more incentive optimal contract for the smaller range of agents who get rent above the reservation utility. If only the volatility is affected, the optimal contract is necessarily nonincentive, unlike in the firstbest case. We also suggest a procedure for finding simple and reasonable contracts, which, however, are not necessarily optimal.
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 Title
 Optimal compensation with adverse selection and dynamic actions
 Journal

Mathematics and Financial Economics
Volume 1, Issue 1 , pp 2155
 Cover Date
 20070401
 DOI
 10.1007/s1157900700022
 Print ISSN
 18629679
 Online ISSN
 18629660
 Publisher
 SpringerVerlag
 Additional Links
 Topics
 Keywords

 Adverse selection
 Moral hazard
 Principalagent problems
 Continuoustime models
 Contracts
 Managers compensation
 C61
 C73
 D82
 J33
 M52
 91B28
 93E20
 Authors

 Jakša Cvitanić ^{(1)}
 Jianfeng Zhang ^{(2)}
 Author Affiliations

 1. Caltech, Humanities and Social Sciences, M/C 22877, 1200 E. California Blvd., Pasadena, CA, 91125, USA
 2. USC Department of Mathematics, 3620 S Vermont Ave, KAP 108, Los Angeles, CA, 900891113, USA