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Suvi Vasama (Humboldt University of Berlin)

27 October 2014 @ 12:45

 

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Details

Date:
27 October 2014
Time:
12:45
Event Category:

“Real Options and Dynamic Incentives”

abstract

We examine a dynamic principal-agent model in which the output is correlated over time. The optimal contract determines a payment schedule from the principal to the agent and a liquidation policy. Incentive compatibility, together with the agent’s limited liability, requires that the firm is liquidated following a history of low returns. With correlated outcome, the optimal liquidation decision depends both on the firm profitability and the history of past returns that can be summarized by the agent’s continuation value. In the beginning, the agent’s continuation value is low and the optimal contract relies on an inefficient liquidation threat to provide the agent incentives. The payments to the agent are delayed, and he is rewarded by promising him a higher continuation value for the future. Once the agent’s value grows high enough, the firm is operated efficiently. In particular, the firm is only liquidated if it is efficient to do so.