Unformatted text preview: Staples’ revenue depends upon Barney’s effort as follows: Bad Economy (Prob. =0.5) Strong Economy Low effort (a=0) 150,000 250,000 High effort (a =1) 250,000 500,000 Barney’s utility function is U = w – C(a), where w denotes his wage income, and C(a) = 10,000a is his cost of effort. a) Briefly explain why this employment relationship constitutes an example for the principal-agent problem. b) In the absence of monitoring, can a fixed wage induce Barney to implement high effort (i.e., a = 1)? Briefly explain. c) Suppose that Staples considers offering Barney two different incentive contracts: A. Profit Sharing Contract: Barney receives 5% of the revenue and no fixed wage. B. Bonus Contract: Fixed wage of $10,000, and a bonus of $30,000 if revenue equals $500,000. What level of effort would Barney implement under each contract? d) Given Barney’s respective effort choice you identified in part c), which contract is preferred by Staples?...
View Full Document
- Spring '09
- Economics, Information asymmetry, low effort, Barney, wage induce Barney, Barney’s effort