A risk based approach to the Principal-Agent problem

Résumé

We suggest a method of characterizing optimal contracts in the classical setting of Principal- Agent problem under hidden action for time inconsistent utility functions. We consider two different models; Hidden Action in the weak formulation and Hidden Contract in the strong formulation. In the first model the agent has full information of the mechanisms behind the cash-flow and the principal wishes to minimize his/her mean-variance utility. In the latter model the agent does not know the structure of the cash-flow and has to protect him/her-self from high levels of risk by an additional participation constraint of variance type. To illustrate the results we consider a fully solved explicit example in the linear quadratic setting.