tute_7ans - Hierarchies, incentives and firm structure...

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1 Hierarchies, incentives and firm structure ECOS3003 Tutorial 7 1. Performance measurement and incentive schemes are jointly determined. Comment. Performance measurement – increases the accuracy of measuring effort; the more accurate, the less risk faced by the agent. This relates to incentive schemes because there is a trade off between costs of making agent bear more risk and the costs of imposing measurement. 2. “One problem with incentive schemes is they motivate too much, rather than not enough”. Comment. In the multi-task principal-agent problem, the P wants a balance between tasks. Hence, incentives can be too strong if individual only focuses on task included in incentive contract (don’t get a balance between tasks) 3. Question 16-2 on page 515. Compensation package sensitive to exogenous factors, so increases the risks that Kraft has to bear – and if she is risk averse this increase the cost of her remuneration package in expected terms. But, it could still be desirable for the firm to include these exogenous factors into Kraft’s contract, because Kraft could reduce the impact of these events on the company by (for example): hedging against gold price; buying earthquake insurance; and after the event ensuring quick repairs. If Kraft knows she is not response, she has less incentive to decrease the cost of exogenous events. Further, if the company alters the compensation package, there could be an issue with influence costs: it increases the incentive for Kraft and other managers to spend effort explaining why events are uncontrollable. 4. Question 16-14 on page 518 Good tree thinning involves quality and quantity; paying by the tree emphasises quantity. Also, it is difficult to observe quality after the fact. 5. Consider a team of three workers. Total output, O, is given by O = 10e1 + 12 e2 + 4e3, where ei is the effort level of worker 1, 2, or 3. The effort costs of each worker are given by ei 2 . (a) What is the first best level of effort for each worker? e1* = 5; e2* = 6; e3* = 2 (b) Now suppose that each worker’s effort level cannot be verified by a court. The firm has to distribute all of the output to the worker (ie O – w1 – w2 – w3 = 0). First, the firm implements the sharing rules that each worker gets one third of total output. What will be the effort levels of each worker in this case? How does your answer differ from your answer in (a) and why? For example, worker 1 now maximises U 1 = 1/3(10e 1 + 12 e 2 + 4e 3 ) – e 1 2 . Differentiate and set equal to zero and you get
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2 10/3 – 2e 1 = 0 e1 = 5/3; e2 = 2; e3 = 2/3 The difference is because the externality: each worker does not receive the full MB from an increase in effort but they incur the full MC. (c) What about the sharing rule when worker 1 gets 10/26 of the output, worker 2 gets 12/26 of the
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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_7ans - Hierarchies, incentives and firm structure...

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