Moral hazard depicted in Markov processes with strategy options

This paper investigates moral hazard issues using Markov processes with payoffs and strategy options, an algorithm developed by Howard [Howard, R.A., 1960. Dynamic Programming and Markov Processes. MIT Technology Press/John Wiley & Sons, NY]. An option consists of a probability vector and an expected payoff for a given state. Each state may have one or more options. Choice of options for each state, called “a strategy”, must be fixed by the manager at the start. An “n-period” manager tries to maximize his/her cumulative payoff (undiscounted or discounted) over n periods. As n → ∞, the manager's strategy becomes in line with owners' interest as the firm lasts indefinitely. Managerial implications of the analyses are examined.