An Agent-Based Model of Delegation Relationships With Hidden-Action: On the Effects of Heterogeneous Memory on Performance

TL;DR

This paper develops an agent-based model of delegation with hidden actions, relaxing key assumptions to explore how information and memory affect incentive scheme convergence and stability in varying environments.

Contribution

It introduces an agent-based adaptation of the hidden-action model, emphasizing the roles of information availability and cognitive capabilities in incentive alignment.

Findings

Stable environments lead to near-optimal incentive schemes.

Environmental turbulence can promote early stability.

The model relaxes assumptions about information and memory.

Abstract

We introduce an agent-based model of delegation relationships between a principal and an agent, which is based on the standard-hidden action model introduced by Holmstr\"om and, by doing so, provide a model which can be used to further explore theoretical topics in managerial economics, such as the efficiency of incentive mechanisms. We employ the concept of agentization, i.e., we systematically transform the standard hidden-action model into an agent-based model. Our modeling approach allows for a relaxation of some of the rather "heroic" assumptions included in the standard hidden-action model, whereby we particularly focus on assumptions related to the (i) availability of information about the environment and the (ii) principal's and agent's cognitive capabilities (with a particular focus on their learning capabilities and their memory). Our analysis focuses on how close and how fast the incentive scheme, which endogenously emerges from the agent-based model, converges to the solution proposed by the standard hidden-action model. Also, we investigate whether a stable solution can emerge from the agent-based model variant. The results show that in stable environments the emergent result can nearly reach the solution proposed by the standard hidden-action model. Surprisingly, the results indicate that turbulence in the environment leads to stability in earlier time periods.