tute_2ans - Hierarchies, incentives and firm structure...

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ECOS 3003 Tutorial 2 1 Hierarchies, incentives and firm structure ECOS3003 Tutorial 2 answers 1. Is it worthwhile for shareholders to seek to completely eliminate incentive problems with managers and directors through means such as monitoring? Why or why not? Possibly not; cost of monitoring versus benefit. If the variables are continuous, monitor up to the point where the MB = MC (of monitoring); eg the MB from the increased effort by a worker = the increase cost from monitoring. It is possible that spot checks and limited monitoring may be optimal. Another issue is who monitors the monitor? (There is scope for the monitor to collude with the party they are meant to be observing.) 2. How does concerns about reputation aid in the enforcement of contracts? Future punishments (cost to reputation) may outweigh short-term gain from cheating. 3. Consider a model with one worker who works for one boss. In each period the worker can work hard or not work at all. If the worker works hard she will create $8 worth of profit. The boss can then decide how to share this profit with the worker (that is, how much of the $8 the worker gets). If the worker does not work she creates $0 profit. There are an infinite number of periods and both parties discount future payoffs by δ . There is a social convention that the worker will work hard if in every previous period the boss gave the worker half of the profit. If this is not the case the worker will not work again in any future periods. What is the δ required to sustain this social convention as an equilibrium? Interpret this social convention as an implicit contract. Boss’s decision, taking worker’s trigger strategy as given. If worker works hard and the boss shares in every period the payoff to the boss is:
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tute_2ans - Hierarchies, incentives and firm structure...

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