Risk-sharing and optimal contracts with large exogenous risks

Jessica Martin and Stéphane Villeneuve
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Jessica Martin: IMT - Institut de Mathématiques de Toulouse UMR5219 - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - INSA Toulouse - Institut National des Sciences Appliquées - Toulouse - INSA - Institut National des Sciences Appliquées - UT - Université de Toulouse - UT2J - Université Toulouse - Jean Jaurès - UT - Université de Toulouse - UT3 - Université Toulouse III - Paul Sabatier - UT - Université de Toulouse - CNRS - Centre National de la Recherche Scientifique
Stéphane Villeneuve: TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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Abstract: What type of delegation contract should be offered when facing a risk of the magnitude of the pandemic we are currently experiencing and how does the likelihood of an exogenous early termination of the relationship modify the terms of a full-commitment contract? We study these questions by considering a dynamic principal-agent model that naturally extends the classical Holmström-Milgrom setting to include a risk of shutdown before the maturity of the contract. We obtain an explicit characterization of the optimal wage along with the optimal action provided by the agent when the shutdown risk is independent of the inherent agency problem. The optimal contract is linear by offering both a fixed share of the output which is similar to the standard shutdown-free Holmström Milgrom model and a linear prevention mechanism that is proportional to the random lifetime of the contract. We then extend the model in two directions. We first allow the agent to control the intensity of the shutdown risk. We also consider a structural agency model where the shutdown risk materializes when the state process hits zero.

Keywords: Principal-Agent problems; Shutdown risk; Hamilton-Jacobi Bellman equations (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-cta, nep-mic and nep-rmg
Note: View the original document on HAL open archive server: https://hal.science/hal-04164688v1
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Published in Decisions in Economics and Finance, 2023, 46 (1), pp.1-43. ⟨10.1007/s10203-023-00386-1⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-04164688

DOI: 10.1007/s10203-023-00386-1

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