Question 1

One possible solution to an incentive problem arising under unobservable actions is:

Accepted Answer

Selling the agent the right to the total production aligns the agent's incentives with the principal's, as the agent will be motivated to maximize output since they benefit directly from it.

Question 2

To qualify as incentive pay, a performance-based compensation program:

Accepted Answer

Incentive pay can use either monetary or non-monetary rewards depending on the organization's culture and goals. Piece rates and commissions are types of monetary rewards, but there are also non-monetary rewards such as recognition, opportunities for advancement, and increased autonomy.

Question 3

Strong incentives are provided by:

Accepted Answer

Pay on performance provides a stronger incentive than fixed salaries alone as it incentivizes employees to work harder and achieve better results in order to earn more pay. Fixed salaries do not provide this level of motivation and may even lead to complacency. Limited pay on performance may still provide some incentive, but is not as strong as a fully incentivized pay structure. Threatening to outsource the job to Bangalore may provide short-term motivation, but is not a sustainable or fair long-term solution.

Question 4

Alfie Kohn and Demming are of the opinion that:

Accepted Answer

Both Alfie Kohn and Demming believe that pay is not a prime motivator for employees. They argue that extrinsic motivators, such as financial incentives, actually undermine intrinsic motivation and distract employees from focusing on the actual work they are doing. Instead, they believe that creating a positive work environment, giving employees autonomy, and fostering a sense of purpose and mastery are more effective ways to motivate employees.

Question 5

The informativeness principle tells us that:

Accepted Answer

The informativeness principle suggests that compensation contracts must use as much information as possible to develop contracts, as long as the cost of obtaining the information is reasonable. This principle ensures that employees are rewarded according to their performance, which can motivate them to perform better. However, there are logistical and economic costs associated with obtaining information, such as time and resources. Therefore, the principle suggests that a reasonable balance must be maintained such that the costs of obtaining the information are not too high compared to the benefits of using that information in the compensation contract.

Question 6

It is better to pool risks because :

Accepted Answer

Pooling risks allows for a reduction in the variability of expected income. By spreading risk across a larger group, the impact of any individual loss or unexpected event can be minimized. While pooling may not necessarily increase expected income, it can provide a more stable and predictable financial outcome.

Question 7

Consider the salary of Mary Sue Nelson, a sales agent for Plain Truth Advertising. Her weekly wage package is W = 1,000 + .4Q, where Q is her dollar volume of sales. Her productivity is Q = 200e +  , where e denotes her hours of effort and  , is a random variable with mean 0. If Mary Sue works an additional hour, the expected value of her wages rises by:

Accepted Answer

To find out how her wages change when she works an additional hour, we need to take the derivative of her wage package with respect to Q and multiply it by the derivative of Q with respect to e:

dW/de = 0.4 * dQ/de

dQ/de = 200 * e^(11 * N(0,1))

So:

dW/de = 0.4 * 200 * e^(11 * N(0,1))

We can simplify this as:

dW/de = 80 * e^(11 * N(0,1))

The expected value of e^(11 * N(0,1)) is e^(0.5 * 11^2) = e^60.5. So:

Expected change in wages = 80 * e^60.5 - 80 = $79.22

Rounded to the nearest dollar, this gives us an expected increase of $80. Therefore, the best choice is B.

Question 8

Since the1980s, the compensation of CEOs in large corporations has been increasingly tied to performance of the common stock of the company. Research now indicates that if the value of the firm changes by $1,000, the wealth of CEO changes by:

Accepted Answer

Research indicates that CEO compensation is often tied to stock performance, and a typical change in CEO wealth for a $1,000 change in firm value is around $10.57, reflecting a small but significant alignment with shareholder interests.

Question 9

Three difficulties that limit the usefulness of ownership in resolving incentive problems are:

Accepted Answer

Wealth constraints can limit the ability of individuals to take ownership and invest in a project, risk aversion can lead individuals to avoid taking on risky projects even when they have ownership, and free-riding can still occur even when ownership is present as individuals may still rely on others to do the work. Bundling is not directly related to the limitations of ownership in resolving incentive problems.

Question 10

Incentives would not be a problem if:

Accepted Answer

If actions were observable, it would be easier to monitor and ensure that individuals are acting in accordance with the desired incentives, reducing the problem of misaligned incentives.

Question 11

Consider the salary of Mary Sue Nelson, a sales agent for Plain Truth Advertising. Her wage package is W = 1,000 + .4Q, where Q is her dollar volume of sales. Her productivity is Q = 200e + , where e denotes her hours of effort and m is a random variable with mean 0. She has an effort cost of C = e² . Under this contract, the expected value of her total wages will be:

Accepted Answer

The answer of Consider the salary of Mary Sue Nelson,...

Question 12

There is scientific evidence to suggest that:

Accepted Answer

There is ample scientific evidence to suggest that agents respond to incentives. This is a fundamental principle of economic theory, and multiple studies across different fields (such as psychology, economics, and neuroscience) have shown that incentives can influence human behavior and decision-making.

Question 13

FancyFoods belongs to the Restaurant Trade Association. One of the services that the trade association provides is monthly data on total regional sales of restaurants. In designing a bonus system for employees, this service:

Accepted Answer

The monthly data on total regional sales of restaurants provided by the Restaurant Trade Association can be useful for designing a bonus system for employees as it may provide low-cost information for performance contracts. This information can be used to set realistic sales targets for employees and measure their performance against the regional sales data. However, it is important to note that this data should not be the only factor considered in determining employee bonuses as there may be other factors that affect sales, such as seasonality, competition, and external events.

Question 14

Consider the salary of Mary Sue Nelson, a sales agent for Plain Truth Advertising. Her wage package is W = 1,000 + .4Q, where Q is her dollar volume of sales. Her productivity is Q = 200e + , where e denotes her hours of effort and m is a random variable with mean 0. She has an effort cost of C = e². Under this contract, her choice of effort will be:

Accepted Answer

To find the optimal choice of effort, we need to maximize Mary Sue's utility, which is given by her wage package minus the effort cost:

U = W - Ce = (1000 + 0.4Q) - Se^(1/2) = (1000 + 0.4(200e + 11m)) - Se^(1/2)

Taking the derivative of U with respect to e and setting it equal to 0, we get:

dU/de = 88Se^(-1/2) - 0.4S = 0

Solving for e, we get:

e = (220/S)^(2)

Now we need to check if this choice of effort is feasible, i.e. if the cost of effort is less than the expected increase in income due to increased sales:

Ce = Se^(1/2) = S(220/S) = 220 < 400

Since the cost of effort is less than the expected increase in income, Mary Sue will choose to work 40 hours per week (i.e. e = 4400/S).

Question 15

Team production is a limiting factor as a solution to incentive problems since:

Accepted Answer

While team production can provide incentives for team members to work together and contribute to a common goal, it also creates the possibility for free-riding or shirking. This occurs when some team members choose to let others carry the workload, knowing that they will still receive the same reward or compensation as the rest of the team. This limits the effectiveness of team production as a solution to incentive problems.

Question 16

The text quotes W. Edwards Deming as saying that "pay is not a motivator." The history of incentive pay plans shows that:

Accepted Answer

The text mentions that the history of incentive pay plans shows a mixed record in success, which means that they do not always work but also do not always fail. Additionally, the text quotes Deming as saying that pay is not a motivator, suggesting that monetary incentives alone may not be enough to motivate employees. Therefore, option C is the best choice.

Question 17

Incentives would not be a problem:

Accepted Answer

If the interests of the employees and the employers were perfectly aligned, then incentives would not be a problem as both parties would benefit from them. However, if their interests conflict, it may be more challenging to create incentives that are satisfactory for both sides.

Question 18

Terence Riggan has four tasks assigned to him on the job: stocking, sales, restocking, and display building. The company wants Terence to spend 50 percent of time on sales, but needs the other tasks done daily. Building an incentive program to get this done is:

Accepted Answer

The answer of Terence Riggan has four tasks assigned to...

Quiz 15: Incentive Compensation