Agency Theory

  • 7-weeks
  • 1.5 credits
  • Prerequisite: None

Agency issues are important in many business settings and the principal-agent model is central in accounting, economics, finance, management, and marketing.  In this course, we provide a focused introduction to the basic moral hazard and adverse selection/screening agency models and then use them to study aspects of managerial compensation and insurance and financial markets, as well as marketing strategies such as price discrimination, price/quality market segmentation, and supply chain management.  As time permits, we may also cover topics in repeated bilateral contracting and/or incomplete contracts and institutional design.

A.    The Kuhn-Tucker method (optimization subject to inequality constraints).

B.    The basic moral hazard problem.  Applications to insurance and supply chain management.

C.    The Holmström-Milgrom (1991) linear moral hazard model.  Applications to managerial compensation, including    the optimal compensation formula, relative performance pay, the Informativeness Principle, and the Equal Compensation Principle (multi-tasking).

D.    The basic adverse selection and screening model.  Applications to price discrimination, price/quality market segmentation, supply chain management, and credit rationing.

E.     Incomplete contracts and institutional design.

F.     Dynamics under full commitment.



Laffont, J. and Martimort, D. “The Theory of Incentives:  The Principal-Agent Model”

Bolton, P. and Dewatripont, M. “Contract Theory”

Hallock, K. and Murphy, K.  “The Economics of Executive Compensation”

Kelley School of Business

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