The value of a successful project is $420,000; the probabilities of success are 1/2 with good supervision and 1/4 without. The manager is risk neutral, not risk averse as in the text, so his expected utility equals his expected income minus his disutility of effort. He can get other jobs paying $90,000, and his disutility for exerting the extra effort for good supervision on your project is $100,000. (a) Show that inducing high effort would require the firm to offer a compensation scheme with a negative base salary; that is, if the project fails, the manager pays the firm an amount stipulated in the scheme. (b) How might a negative base salary be implemented in reality? (c) Show that if a negative base salary is not feasible, then the firm does better to settle for the low-pay, low-effort situation.
The value of a successful project is $420,000; the probabilities of success are 1/2 with good supervision and 1/4 without. The manager is risk neutral, not risk averse as in the text, so his expected utility equals his expected income minus his disutility of effort. He can get other jobs paying $90,000, and his disutility for exerting the extra effort for good supervision on your project is $100,000.
(a) Show that inducing high effort would require the firm to offer a compensation scheme with a negative base salary; that is, if the project fails, the manager pays the firm an amount stipulated in the scheme.
(b) How might a negative base salary be implemented in reality?
(c) Show that if a negative base salary is not feasible, then the firm does better to settle for the low-pay, low-effort situation.
Trending now
This is a popular solution!
Step by step
Solved in 4 steps
