Consistency Between Principal and Agent With Differing Time Horizons: Computing Incentives Under Risk

European Journal of Operational Research, 277(2019), 1113-1123

Posted: 24 May 2019

Date Written: March 30, 2019

Abstract

In a parsimonious model, we analyze how to obtain consistent incentives when both principal and agent are risk-averse and when a setting prevails in which the agent may have a shorter time horizon than the principal. Intertemporal dependencies in risky cash flows are taken into account.

Building on the fundamental results produced by Rogerson (Journal of Political Economy 105(4):770–795, 1997) and Reichelstein (Review of Accounting Studies 2(2):157–180, 1997), we establish a new risk allocation scheme, which enables consistent incentives to be achieved. Thereby, we demonstrate that the resulting performance measures correspond to an affine transformation of previous and current residual incomes or, alternatively, cash flows in such a way that information asymmetry between principal and agent is still possible. The risk allocation technique developed may prove useful in other contexts.

Keywords: Decision analysis, Investment decision, Intertemporal dependencies, Performance measure, Relative benefit cost allocation

JEL Classification: D82, G31, M41

Suggested Citation

Schosser, Josef, Consistency Between Principal and Agent With Differing Time Horizons: Computing Incentives Under Risk (March 30, 2019). European Journal of Operational Research, 277(2019), 1113-1123. Available at SSRN: https://ssrn.com/abstract=3378472

Josef Schosser (Contact Author)

University of Passau ( email )

Innstrasse 27
Passau, 94032
Germany

Here is the Coronavirus
related research on SSRN

Paper statistics

Abstract Views
98
PlumX Metrics