Manegerial Economics
* Chapter 1: Problems 2, 3, and 6 * Chapter 2: Problems 1, 5, and 6 * * Chapter 1 *
2. If you decide to pay 1 percent of this amount (in Question 1) as a cash bonus, what performance level (what share price or shareholder value) in the table should trigger the bonus? Suppose you decide to elicit high CEO effort when, and if, medium luck occurs by paying a bonus should the company’s value rise to $800,000,000. What criticism can you see of this incentive contract plan?
Solutions:
We find both contracts elicit lower-thanpredicted levels of effort. Effort choices elicited by the option contract do not differ significantly from effort choices elicited by the stock contract except for male subjects whose choices suggest a strategy of exploration. The option contract elicits a higher effort level for these subjects than a stock contract. This is evidence that, for a definable subset of the population, employee effort choices will differ across stock-based and option-based compensation contracts that are similarly costly to the employer.
3. Suppose you decide to elicit high CEO effort when, and if, good luck occurs by paying a bonus only for an increase in the company’s value to $1,000,000,000. What criticism can you see of this incentive contract plan? Solutions: Of course, the shareholders would also like to elicit High Effort with Medium and Bad Luck since those behaviors would also increase company profit. But Good Luck and Low Effort cannot be distinguished from Moderate Effort and Bad Luck, and furthermore, there is no incentive for High Effort. 6. In an effort to identify the share price that should trigger a bonus, the payment for the CEO, and maximize shareholder value, how much would you, the Compensation Committee, be willing to pay an auditor to examine the expense and revenue flows in real time and deliver perfect forecasting information about the “luck” the firm is
2. If you decide to pay 1 percent of this amount (in Question 1) as a cash bonus, what performance level (what share price or shareholder value) in the table should trigger the bonus? Suppose you decide to elicit high CEO effort when, and if, medium luck occurs by paying a bonus should the company’s value rise to $800,000,000. What criticism can you see of this incentive contract plan?
Solutions:
We find both contracts elicit lower-thanpredicted levels of effort. Effort choices elicited by the option contract do not differ significantly from effort choices elicited by the stock contract except for male subjects whose choices suggest a strategy of exploration. The option contract elicits a higher effort level for these subjects than a stock contract. This is evidence that, for a definable subset of the population, employee effort choices will differ across stock-based and option-based compensation contracts that are similarly costly to the employer.
3. Suppose you decide to elicit high CEO effort when, and if, good luck occurs by paying a bonus only for an increase in the company’s value to $1,000,000,000. What criticism can you see of this incentive contract plan? Solutions: Of course, the shareholders would also like to elicit High Effort with Medium and Bad Luck since those behaviors would also increase company profit. But Good Luck and Low Effort cannot be distinguished from Moderate Effort and Bad Luck, and furthermore, there is no incentive for High Effort. 6. In an effort to identify the share price that should trigger a bonus, the payment for the CEO, and maximize shareholder value, how much would you, the Compensation Committee, be willing to pay an auditor to examine the expense and revenue flows in real time and deliver perfect forecasting information about the “luck” the firm is