SSE/EFI Working Paper Series in Economics and Finance
Holger M. Müller
The First-Best Sharing Rule in the Continuous-Time Principal-Agent Model with Exponential Utility
Abstract: The continuous-time principal-agent model with exponential
utility developed by Holmström and Milgrom (1987) and generalized by
Schättler and Sung (1993, 1996) and Sung (1995) admits a simple closed-form
solution: The second-best sharing rule is linear in output. Unfortunately,
the first-best sharing rule has never been derived. In this note, we show
that the first-best sharing rule is also linear in output, which fits in
nicely with an analogous result from static risk-sharing theory. In
addition, we show that the slope is equal to the principal’s share of total
absolute risk-aversion. This result is consistent with Borch’s (1962)
fundamental theorem of Pareto-optimal risk-sharing.
Keywords: Moral hazard; continuous-time principal-agent problem; (follow links to similar papers)
JEL-Codes: D82; (follow links to similar papers)
8 pages, December 1996
Published in Journal of Economic Theory 79/2, 1998, 276-280
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- This paper is forthcoming as:
Müller, Holger M., 'The First-Best Sharing Rule in the Continuous-Time Principal-Agent Model with Exponential Utility', Journal of Economic Theory.
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