Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model

We derive the optimal dynamic contract in a continuous‐time principal‐agent setting, and implement it with a capital structure (credit line, long‐term debt, and equity) over which the agent controls the payout policy. While the project's volatility and liquidation cost have little impact on the firm's total debt capacity, they increase the use of credit versus debt. Leverage is nonstationary, and declines with past profitability. The firm may hold a compensating cash balance while borrowing (at a higher rate) through the credit line. Surprisingly, the usual conflicts between debt and equity (asset substitution, strategic default) need not arise.     

Dynamic CEO Compensation

We study optimal compensation in a dynamic framework where the CEO consumes in multiple periods, can undo the contract by privately saving, and can temporarily inflate earnings. We obtain a simple closed‐form contract that yields clear predictions for how the level and performance sensitivity of pay vary over time and across firms. The contract can be implemented by escrowing the CEO's pay into a “Dynamic Incentive Account” that comprises cash and the firm's equity. The account features state‐dependent rebalancing to ensure its equity proportion is always sufficient to induce effort, and time‐dependent vesting to deter short‐termism.     

A Continuous-Time Version of the Principal–Agent Problem

This paper describes a new continuous-time principal–agent model, in which the output is a diffusion process with drift determined by the agent's unobserved effort. The risk-averse agent receives consumption continuously. The optimal contract, based on the agent's continuation value as a state variable, is computed by a new method using a differential equation. During employment, the output path stochastically drives the agent's continuation value until it reaches a point that triggers retirement, quitting, replacement, or promotion. The paper explores how the dynamics of the agent's wages and effort, as well as the optimal mix of short-term and long-term incentives, depend on the contractual environment.