Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:
A) a flat salary alone.
B) a flat salary plus some return to estimates of effort.
C) only a profit share.
D) a flat salary plus a profit share related only indirectly to individual effort.
E) a flat salary plus a profit share that is equal to the share accruing to owners.

Question

Quizplus · Accepted Answer

The optimal employment contract for managers in the given scenario would be a combination of a flat salary and a profit share related to the firm's overall success. This is because revenue risk and unobservable output make it difficult to measure individual effort accurately, and tying compensation directly to individual effort may lead to adverse incentive effects. However, a profit share that is indirectly related to individual effort can still provide motivation for managers to work towards maximizing the firm's profitability and value. A flat salary provides a baseline compensation for managers, which ensures some stability in their income and helps to attract and retain talent.

Optimal Employment Contracts for Managers,given Revenue Risk and Unobservable Output,consist