Hidden Action Research Articles

A risk based approach to the principal–agent problem

PurposeWe aim to generalize the continuous-time principal–agent problem to incorporate time-inconsistent utility functions, such as those of mean-variance type, which are prevalent in risk management and finance.Design/methodology/approachWe use recent advancements of the Pontryagin maximum principle for forward-backward stochastic differential equations (FBSDEs) to develop a method for characterizing optimal contracts in such models. This approach addresses the challenges posed by the non-applicability of the classical Hamilton–Jacobi–Bellman equation due to time inconsistency.FindingsWe provide a framework for deriving optimal contracts in the principal–agent problem under hidden action, specifically tailored for time-inconsistent utilities. This is illustrated through a fully solved example in the linear-quadratic setting, demonstrating the practical applicability of the method.Originality/valueThe work contributes to the existing literature by presenting a novel mathematical approach to a class of continuous time principal–agent problems, particularly under hidden action with time-inconsistent utilities, a scenario not previously addressed. The results offer potential insights for both theoretical development and practical applications in finance and economics.

Base of the chain (BoC) sourcing challenges: The role of institutional voids and social agency problems

Due to various factors, including the institutional context of suppliers, the successful implementation of sustainability initiatives remains a persistent challenge for purchasing and supply management (PSM) professionals. Sourcing from the Base of the Chain (BoC) requires buyers to be cognizant of and assess challenges inherent in engaging with the Bottom of the Pyramid (BoP) institutional context. Designing governance structures that facilitate the simultaneous pursuit of economic and social goals demands a thorough understanding of these challenges and their contextual antecedents. The literature has addressed institutional voids and incompatibilities between buyer-BoC supplier institutional contexts as critical factors informing interventions aimed at overcoming sourcing challenges. Drawing upon social agency theory, our study advances these debates. We argue that the broader institutional and social context serves as the contextual antecedents to principal-agent (P-A) relationships established between buyers and their BoC suppliers. This perspective provides a more enriched explanation for the antecedents of BoC sourcing challenges. We draw on a multiple case study incorporating 31 interviews and archival data of five BoC sourcing programs within the Australian agribusiness sector. Our findings shed light on how BoC institutional voids cause BoC sourcing challenges across supplier and product domains by inducing hidden information, hidden action, and hidden logic as social agency problems. Hidden logic, a new type of social agency problem identified in our study, refers to the agents' socially constructed sets of assumptions, values, beliefs, and traditions that are invisible to the principals. Consequently, we present insights into why governance structures addressing BoC sourcing challenges may vary across institutional contexts, providing practical guidance for buyers in developed economies concerning the subsequent design and execution of effective BoC sourcing strategies.

The role of normative analysis in markets with hidden knowledge and hidden actions

The role of normative analysis in markets with hidden knowledge and hidden actions

Designing contracts and information jointly

We consider a Bayesian persuasion problem with hidden action. When the principal can decide on both information structure and monetary transfer, which relies on the stochastic output, then full separation or full pooling contract is optimal.

Dynamic Mechanism Design for Repeated Markov Games with Hidden Actions: Computational Approach

This paper introduces a dynamic mechanism design tailored for uncertain environments where incentive schemes are challenged by the inability to observe players’ actions, known as moral hazard. In these scenarios, the system operates as a Markov game where outcomes depend on both the state of payouts and players’ actions. Moral hazard and adverse selection further complicate decision-making. The proposed mechanism aims to incentivize players to truthfully reveal their states while maximizing their expected payoffs. This is achieved through players’ best-reply strategies, ensuring truthful state revelation despite moral hazard. The revelation principle, a core concept in mechanism design, is applied to models with both moral hazard and adverse selection, facilitating optimal reward structure identification. The research holds significant practical implications, addressing the challenge of designing reward structures for multiplayer Markov games with hidden actions. By utilizing dynamic mechanism design, researchers and practitioners can optimize incentive schemes in complex, uncertain environments affected by moral hazard. To demonstrate the approach, the paper includes a numerical example of solving an oligopoly problem. Oligopolies, with a few dominant market players, exhibit complex dynamics where individual actions impact market outcomes significantly. Using the dynamic mechanism design framework, the paper shows how to construct optimal reward structures that align players’ incentives with desirable market outcomes, mitigating moral hazard and adverse selection effects. This framework is crucial for optimizing incentive schemes in multiplayer Markov games, providing a robust approach to handling the intricacies of moral hazard and adverse selection. By leveraging this design, the research contributes to the literature by offering a method to construct effective reward structures even in complex and uncertain environments. The numerical example of oligopolies illustrates the practical application and effectiveness of this dynamic mechanism design.

An Approach to Stochastic Dynamic Games with Asymmetric Information and Hidden Actions

An Approach to Stochastic Dynamic Games with Asymmetric Information and Hidden Actions

Dynamic Contracting in Asset Management Under the Investor-Partner-Manager Relationship

Navigating the Complex Web of Incentives in Asset Management: A Study on Investor, Partner, and Manager Dynamics In a recent study titled “Dynamic Contracting in Asset Management Under the Investor-Partner-Manager Relationship,” the researchers delve into the intricate world of incentives in asset management. The focus is on the complex interplay of actions and relationships among three key players: an investor, an investment company partner, and a fund manager. This study uniquely explores the challenges of incentive contracts in an environment where the actions of these individuals are not fully observable to each other. It introduces a hierarchical contracting framework to understand the dynamics under the hidden actions. For instance, the research reveals how the optimal action of the manager is influenced by the cost of the partner’s actions and extends the analysis to scenarios involving multiple managers. This work sheds light on the often hidden intricacies of asset management, providing valuable perspectives for the different players’ collaborative efforts for optimal outcomes in this industry.

Demand forecasting, signal precision, and collusion with hidden actions

We analyze how higher demand-forecasting precision affects firms' chances of sustaining supracompetitive profits, depending on whether actions are observable or hidden. We identify a dual role of improving forecasting ability for situations in which actions are hidden. Improved forecasting ability increases the temptation for firms to deviate, reducing profits; at the same time, such ability reduces and eventually eliminates the uncertainty over whether deviations are occurring. Our framework, in which firms decide on prices and promotional activities, reveals a U-shaped relationship between profits and predictive ability. Generally, collusive profits may increase or decrease in signal precision, depending on action observability, highlighting the importance of industry-specific considerations for regulatory interventions and competition policy.

Dynamic incentives for sustainable contract farming

The rise of contract farming has transformed millions of farmers' lives. We study a new class of contract farming problems, where the farmer holds superior information and can invest effort to improve productivity over time. Despite their prevalence, the literature offers little guidance on how to manage such farmers with dynamic incentives. We build a game‐theoretic model that captures the dynamic incentives of learning and gaming, with hidden action and information. We characterize the optimal contract: it internalizes both the vertical and intertemporal externalities, with performance pay and deferred payment; the performance pay is to motivate the farmer to invest and improve the relationship‐specific productivity; the deferred payment is to ensure that the farmer is willing to share information and behave honestly over time. Even with random yield, the optimal contract can still have a simple implementation of a yield‐adjusted revenue‐sharing policy. Using real data, we show that the learning effect is significant. We then quantify when and how contract farming can improve smallholder farmers' productivity and income, creating shared value. We find when buyers have a long‐term perspective and can internalize the benefit of farmer improvement, they will pay higher prices to ensure farmers' long‐term viability. Our results inform the policy debate on contract farming: traditional procompetitive policies (based on spot transactions) can be counterproductive for modern agrifood value chains, hurting both buyers and farmers.

Optimal Task Scheduling under Adverse Selection and Hidden Actions

A Principal owns a project consisting of several tasks. Tasks differ, both in their innate success probabilities and their incremental benefits. Moreover, only specialists can perform these tasks. Subject to moral hazard and adverse selection, in what order should the Principal commission the tasks, and when should she terminate the project? What investments into changing tasks’ characteristics yield the highest marginal profit? These are typical issues that arise in sequencing R&D activities and other sequential production processes. We show that, despite informational constraints, a simple index—a task’s effective marginal contribution—determines the optimal schedule/mechanism. (JEL D82, L23, L24, L65, M11, O31)

An Approach to Stochastic Dynamic Games with Asymmetric Information and Hidden Actions

An Approach to Stochastic Dynamic Games with Asymmetric Information and Hidden Actions

Learning from Manipulable Signals

We study a dynamic stopping game between a principal and an agent. The principal gradually learns about the agent's private type from a noisy performance measure that can be manipulated by the agent via a costly and hidden action. We fully characterize the unique Markov equilibrium of this game. We find that terminations/market crashes are often preceded by a spike in manipulation intensity and (expected) performance. Moreover, due to endogenous signal manipulation, too much transparency can inhibit learning and harm the principal. As the players get arbitrarily patient, the principal elicits no useful information from the observed signal. (JEL C73, D82, D83, G24, M13)

Randomization is optimal in the robust principal-agent problem

A principal contracts with an agent, who takes a hidden action. The principal does not know all of the actions the agent can take and evaluates her payoff from any contract according to its worst-case performance. Carroll (2015) showed that there exists a linear contract that is optimal within the class of deterministic contracts. This paper shows that, whenever there is an optimal linear contract with non-zero slope, the principal can strictly increase her payoff by randomizing over deterministic, linear contracts. Hence, if the principal believes that randomization can alleviate her ambiguity aversion, then restricting attention to the study of deterministic contracts is with loss of generality.

Study of Ashab Al-Kahf's Story in the Book of Fadhâ’il al-Khamsah min al-Shihahi al-Sittah: A Naturalistic Hermeneutical Perspective

This study discusses the story of Ashab al-Kahf in the book of Fadhâ’il al-Khamsah min al-Shihahi al-Sittah by As-Sayyid Murtadha Al-Huseiny Fairuzabadi in which there are interesting and intelligent dialogues between Ali bin Abi Talib and a Jewish priest. Ali bin Abi Talib was one of the Prophet Muhammad’s companions who was smart and very trusted. The story of Ashabul-Kahf contains many lessons and life’s wisdom for humans who consistently maintain their faith and stay away from the power oppressive center to their people. The formal object of this research is the story of Ashabul-Kahf which is very popular in Islamic society, both in the Arab world and outside the Arab world. The material object uses Fadhâ’il al-Khamsah min al-Shihahi al-Sittah Book. This study uses the naturalistic hermeneutic theory by Mantzavinos. The results showed that the actions of seven young men who fled to the cave due to they were being chased by the tyrannical King Dikyanus and they did not feel like sleeping in the cave for 309 years. This research reveals a series of material events since they fled from the kingdom and were chased by King Dikyanu’s army and finally they fell asleep in the cave for more than three centuries until they woke up from their long sleep and were again killed by God. Between one event material with others each other has a relationship of interrelated meaning. In this study, it is proven that the use of naturalistic hermeneutic theory can guide researchers in revealing the hidden actions meaning of the seven young men from the pursuit of King Dikyanus in the cave. The meaning revealed is that there is a causal relationship between the story of Ashabul-Kahf text and its readers (researchers). The story complexity in the story’s text is later explained through the nexus concept, which essentially looks for material that occurs in the historical reality area and expresses it through an exclusive causal relationship. Therefore, through this nexus, the problematic meaning of Ashabul-Kahf story can be revealed.

Was Sarbanes–Oxley Costly? Evidence from Optimal Contracting on CEO Compensation

ABSTRACTThis paper investigates the effects of regulatory interventions on contracting relationships within firms by examining the impacts of the Sarbanes–Oxley (SOX) Act on CEO compensation. Using panel data of the S&P 1500 firms, it quantifies welfare gains from a principal–agent model with hidden information and hidden actions. It finds that SOX: (1) reduced the conflict of interest between shareholders and their CEOs, mainly by reducing shareholder loss from CEOs deviating from their goal of expected value maximization; (2) increased the cost of agency, or the risk premium CEOs are paid to align their interests with those of shareholders; (3) increased administrative costs in the primary sector (which includes utilities and energy) but the effect in the other two broadly defined sectors, services and consumer goods, was more nuanced; and (4) had no effect on the attitude of CEOs toward risk.

Salience Bias and Overwork

In this study, we enrich a standard principal–agent model with hidden action by introducing salience-biased perception on the agent’s side. The agent’s misguided focus on salient payoffs, which leads the agent’s and the principal’s probability assessments to diverge, has two effects: First, the agent focuses too much on obtaining a bonus, which facilitates incentive provision. Second, the principal may exploit the diverging probability assessments to relax participation. We show that salience bias can reverse the nature of the inefficiency arising from moral hazard; i.e., the principal does not necessarily provide insufficient incentives that result in inefficiently low effort but instead may well provide excessive incentives that result in inefficiently high effort.

Образовательная практика чтения (на материале изучения творчества Ф.М. Достоевского в средней общеобразовательной школе)

The relevance of the research is determined by finding the reasons for modern schoolchildren's decline in the motivation for reading in general and classical literature, in particular. According to the authors, the change in the semiosis of culture (change of the verbal code by a visual one), as well as the rigidity of the organization of reading practices in teaching, can be named among the circumstances that cause the reading crisis. In this context, the “golden pool” of the Russian literature is facing the threat of losing its culturegenerating potential. Goal: a critical analysis of the practice of organizing the reading of Fyodor Dostoevsky's novel “Crime and Punishment” in secondary schools; highlighting its basic constituents and hidden actions that program the students' perception; identifying the directions of re-actualization of a classical literary text potential in school teaching. Objectives: the reconstruction of student and pedagogical discourse positions that objectify a literary work; a comparative analysis of educational dispositions; highlighting the discursive constituents of educational reading practices; identifying the directions of their renovation that make students' interest in reading a literary text more active. Methods of research: a critical discourse analysis; a conversion analysis; a pragmatic interpretation; survey methods (interviews, a focus group, experts' opinions). There have been found significant gaps in the dispositions of participants in educational reading, the presence of which is masked by common procedures of compulsion to communicative consent. Established were the key constituents of these practices (authorization, decontextualization, deactualization), which reduce the text of a literary work to the teacher's statements and the text in the textbook, which substitute the reading activity by a pseudo-literary replication. Substantiated is the didactic necessity of limiting the range of students' everyday experience actions of their educational interaction with an artifact text, alongside with developing a set of readers' new competencies based on the activation of perceptual-figurative parameters of a literary work perception and students' independent comprehension of the text. There have been established discursive operations of educational recontextualization (transformation into an academic subject) of the Russian author Fyodor Dostoevsky's literary works, the objectification and reorganization of which will contribute to the growth of the generativeness of educational relations and increase their cultural-generating effectiveness based on links with the text-artifact. The general orientation of the subject “Russian Literature” towards the assimilation of methodologically codified material by students, which produces both the unification of the literary works being studied and the despecification of the cultural contributions of their authors, as well as the leveling of the individual character of the perception literary works by students, was critically assessed. Particular attention is drawn to the compulsion to communicative agreement (given the pedagogical perspective) in an educational interaction, which hampers a critical analysis of the text by school students, as well as the formation of a variety of reading practices. The optimization of the situation in teaching is consistent with the limitation of the literary component in studying the classical literary heritage, as well as with the expansion of the intermediary resource of visualization in relations with the text-artifact, and, above all, the activation of the ecphrasic dimension of reading a literary work.

Hostility in Teams and Hidden Action

Hostility in Teams and Hidden Action

A novel single-principal-multiple-agent repeated game model and solution method for performance assurance of emergency supplies

Guaranteeing the quality or performance of emergency supplies is crucial for the prompt execution of disaster relief or meeting emergency needs of the affected people. However, given the incentives of gaining subsidies or reducing costs, agents who operate reserve rotation commonly take hidden actions for their own benefits. Such repeated moral hazard problems become serious for the capacity-constrained principal who should simultaneously monitor multiple agents. Considering the physical state transition determined by the agents' hidden actions, this study proposes the definition, conditions, and generating algorithms of (Restricted) Experience Based Equilibria in multi-agent systems with the action selection constraint of the principal to tackle this type of problem. Grain quality assurance problem in a two-enterprise system is then adopted to test the validity of the game model and solution methods, where the rationality and generality of the proposed strategies are further verified in three-enterprise systems. An interesting result from comparing the on-equilibrium strategies with and without the monitoring capacity constraint shows that the lower the monitoring capacity, the higher monitoring effort the principal must exert. This finding reveals that the monitoring capacity is not for actual use but for guiding and threatening the action choices of the agents. Therefore, when the principal fails to improve the monitoring capacity in a short period, making strategies that could show “virtual capabilities” is better. However, from the perspective of long-term stability, the necessity for the principal to improve this capacity is absolute.

Menuless and Preference-Free Screening Contracts for Fund Managers

We propose a family of incentive contracts that can attract some fund managers who are favored by investors and deter any manager who is unfavorable to some investors. The contract problem has hidden types, hidden actions, hidden knowledge of preferences, and opportunity cost. In contrast to standard screening contracts, our contracts neither depend explicitly on the utilities of the managers and investors nor have a menu of choices. The contracts have two crucial components: (i) a first- loss deposit to be used to offset some of the principal’s losses and (ii) a liquidation boundary. A case study is also given.