The dynamics of bargaining power in a principal-agent model

Abstract

This article develops a dynamic principal–agent model that integrates bargaining power as an evolving state variable, governed by a bargaining drift coefficient that links its trajectory to firm performance and agent compensation. The model examines how initial bargaining power shapes salary trajectories and how bargaining drift influences its adaptation over time in response to performance outcomes. By modeling these dynamics, the study highlights the role of incentives in driving the evolution of bargaining power, emphasizing the long-term impact of initial conditions on compensation structures. A key contribution is the formulation of an empirical equation that connects agent compensation and performance with bargaining drift, offering a framework for real-world validation. Beyond CEO pay, the framework extends to other performance-based environments, such as sports and academia, where shifting power relationships shape long-term contracts. By introducing a computational algorithm for multiobjective optimization, the study enhances the practical implementation of bargaining power dynamics, offering valuable insights for both theoretical modeling and governance applications.