Large risks, limited liability, and dynamic moral hazard

Bruno Biais, Thomas Mariotti, Jean Rochet and Stephane Villeneuve
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Thomas Mariotti: GREMAQ - Groupe de recherche en économie mathématique et quantitative - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique

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Abstract: We study a continuous-time principal-agent model in which a risk-neutral agent with limited liability must exert unobservable effort to reduce the likelihood of large but relatively infrequent losses. Firm size can be decreased at no cost or increased subject to adjustment costs. In the optimal contract, investment takes place only if a long enough period of time elapses with no losses occurring. Then, if good performance continues, the agent is paid. As soon as a loss occurs, payments to the agent are suspended, and so is investment if further losses occur. Accumulated bad performance leads to downsizing. We derive explicit formulae for the dynamics of firm size and its asymptotic growth rate, and we provide conditions under which firm size eventually goes to zero or grows without bounds.

Keywords: Econometrics; Statistical method; Growth rate; Continuous time; Finance Risk model; Econométrie; Méthode statistique; Taux croissance; Temps continu; Finance Modèle risque; Sciences actuarielles; 62P05 (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (150)

Published in Econometrica, 2010, 78 (1), pp.73-118. ⟨10.3982/ECTA7261⟩

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Related works:
Journal Article: Large Risks, Limited Liability, and Dynamic Moral Hazard (2010)
Working Paper: Large Risks, Limited Liability and Dynamic Moral Hazard (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:halshs-00491470

DOI: 10.3982/ECTA7261

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