# tute_6ans - Hierarchies incentives and firm structure...

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ECOS3003 Tutorial 6 1 Hierarchies, incentives and firm structure ECOS3003 Tutorial 6 1. In the following principal-agent problem suppose the agent can put in one or no units of effort, ie e = 1 or e = 0. Her utility is given by U(w,e) = (w) 0.5 – e, where w is the wage received and e is the level of effort. The agent’s outside opportunity yields a utility of u = 1. If the effort level is e = 1 then the total revenue will be 30 for sure. If the effort level is e=0 then total revenue will be 30 with probability 1/10 and 10 with probability 9/10. The principal is risk neutral and maximises his expected revenue minus the wage. He will devise a contract that pays a wage w 10 when revenue is 10 and w 30 when revenue is 30 and offer it to the agent. Effort is not observable by the principal. (a) Is the agent risk averse, risk neutral or a risk lover? (b) If the principal wishes to induce the agent to put in low effort, he will offer a flat wage (ie w 10 = w 30 ). Why? (c) Write out the incentive compatibility and individual rationality constraints to induce effort level e=1.

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## This note was uploaded on 11/02/2010 for the course ECOS 3003 taught by Professor Andrewwait during the Three '10 term at University of Sydney.

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tute_6ans - Hierarchies incentives and firm structure...

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