Lecture 5 - Agency Theory 2 (Application) Flashcards
Under the UA’s new compensation plan, the firm would eliminate the performance incentive program that awarded workers up to $375 for each quarter that the airline met operational goals.
Instead, employees would enter a lottery system that involved huge prizes, including $100,000 cash and a Mercedes-Benz sedan. Only workers with perfect attendance records for the quarter would be eligible.
Which one(s) of the following statements do you agree with?
A) From the perspective of principal-agent theory, introducing the lottery system made sense if agents are young and comes from a risk-taking culture
B) The lottery-system increases A’s uncertainty with respect to achieving his bonus - higher risk
C) As do not know the probabilities of winning - further increases risk
D) The successfulness of the lottery program depends greatly on individual As’ risk aversion
E) The program may incentivize As to maintain perfect attendance but not to perform well at work - free-rider issues and shirkage
F) Uncontrollable random factors may influence attendance records - further increases risk
WRONG: A) the probability of the program succeeding may increase if agents are young and prefer taking risk. However, all else equal, the program induced additional risk on the agent, which theoretically should not lead to higher efficiency without proper risk premium
Incentive management essentially concerns maximizing the total value of the relationship with the agent. This can be done through three main levers: which?
1) Incentive intensity: the size of the incentive β
2) Monitoring intensity: amount of resources to be invested in order to properly estimate the agent’s true effort
3) Type of incentive pay
There are several types of incentive pay that the principal can pursue in order to maximize the value of his/her relationship with the agent.
When pay is tied to gains in measure of group “success” (productivity, costs, quality, etc.), this is referred to as:
A) Efficiency wages
B) Profit-sharing
C) Gainsharing
D) Piece rates
C) Gainsharing: refers to group incentives.
Examples incl. waiters’ tip pooping and the fruit orchard example
There are several types of incentive pay that the principal can pursue in order to maximize the value of his/her relationship with the agent.
When pay is tied to profits of the firm (firm-level rather than group level), this is referred to as:
A) Efficiency wages
B) Profit-sharing
C) Gainsharing
D) Piece rates
B) Profit-sharing
There are several types of incentive pay that the principal can pursue in order to maximize the value of his/her relationship with the agent.
When paying employees a “premium” – more than the going market rate of their services: (overpayment in order to incentivise) - if they deviate from principal’s objectives, they are fired, which leads to their loss from deviation being significant due to extraordinary pay.
This is referred to as:
A) Efficiency wages
B) Profit-sharing
C) Gainsharing
D) Piece rates
A) Efficiency wages: Ford’s $5-Day
There are several types of incentive pay that the principal can pursue in order to maximize the value of his/her relationship with the agent.
When pay is tied to the amount of output produced, this is referred to as:
A) Efficiency wages
B) Profit-sharing
C) Gainsharing
D) Piece rates
D) Piece rates
Which implications does Efficiency wages as a incentive type NOT have?
A) Money at risk for A - making it more costly for A to get caught shirking and being fired
B) Reduced monitoring costs: with higher money at risk, A is more self-disciplined
C) Reduced turnover rates and concurrent hiring/training costs: FTEs are more motivated to stay at the firm
D) Additional risk premium must be paid to compensate employees for the higher amount of money at risk
E) Willingness to help co-workers decreases
F) Firm productivity will increase as response to increased productivity of each worker
WRONG:
D) Additional risk premium must be paid to compensate employees for the higher amount of money at risk
E) Willingness to help co-workers decreases: this is not one of the expected implications
If the expected level of pay is constant, employees may prefer time-based over piece rate
TRUE/FALSE
TRUE: piece rate is riskier for A, who due to the assumed risk-aversion, will prefer the safer option. This preference of the safer option will be further intensified if the production process is uncertain (high circumstantial effects)
Following statement is NOT true about piece rates as an incentive type:
A) will lead to agents prioritizing quantity over quality
B) causes employee self-selection on productivity and risk-aversion (only certain FTEs will be attracted)
C) A risk premium is not necessary, since only the risk-loving agents will take the job
D) Is advantageous due to higher expected productivity and higher attraction of workers with right characteristics
E) willingness to help co-workers will decrease if the piece rate compensation happens on individual basis
F) FTEs are likely to treat equipment poorer due to sole focus being output
G) cost of output monitoring will decrease
WRONG:
C) A risk premium is STILL necessary, even if only the risk-loving agents will take the job - the standard assumption is that regardless of A’s characteristics, he will all-else-equal be risk-averse to some degree
G) cost of output monitoring will necessarily INCREASE - A’s risk is increased by piece rates, and is further intensified if the monitoring is poor. Thus, for piece rates to be efficient, proper output monitoring must be implemented
According to Jirjan & Stephan, 2004, which of the following observations are most prominent in explaining why women are more likely to be paid by piece than men?
A) Shorter tenure than men: piece rates would allow women to make money faster
B) Greater demand for flexible work hours: allowing proper family care-taking and catching up on work later
C) Discrimination: piece rates offer an objective performance measure and shields the compensation from wage discrimination
C) Discrimination: piece rates offer an objective performance measure and shields the compensation from wage discrimination
Note: all other observations were correct, but C was found as the most significant factor
As a means to maximize value through incentive management, one can adjust the incentive intensity (β). Which of the following is(are) the advantages of higher β?
A) Enabling agent self-selection: laggards and shirkers will not be attracted to the workplace
B) Advantageous when effort and productivity has high incentive elasticity: A will provide higher effort if they face higher incentives
C) Workers become more skilled: it fosters upgrading of skills and knowledge if proper incentive for this is offered
D) All of the above
E) two of the above
D) All of the above
As a means to maximize value through incentive management, one can adjust the incentive intensity (β). Which of the following is(are) NOT disadvantages of higher β?
A) If a task is complex and effort level is difficult to properly observe, this makes high β more risky for A
B) Multi-tasking problem: FTEs may be less willing to help colleagues due to higher focus on individual performance
C) It can lead to shirking and free-rider problems if β is too high
D) It can be difficult to observe a “normal”/ expected effort level for which β=0 - What is the benchmark?
WRONG: C) It can lead to shirking and free-rider problems if β is too high
Monitoring intensity is one of the means for efficient incentive management.
Which of the following statements are NOT true with respect to monitoring intensity?
A) Monitoring reduces the variance Var(θ) on the estimated effort by the agent - increases the ability to properly measure A’s actual effort
B) Increased monitoring entails that A will know that his/her risk has declined
C) Monitoring intensity has a negative effect on the agent’s demanded risk-premium
D) More value is created in the P and A relationship with higher monitoring intensity
E) Given mostly monitoring, one should increase monitoring until marginal benefit of monitoring equals marginal cost of monitoring
All options are correct
In the study by Lazear about piece rate compensation at Safelite, which observations were made from the introduction of performance-based pay?
A) Output per worker increased significantly (44%)
B) Firm level output increased as ambitious workers would produce more
C) Profits would risk, and so would wages
D) Output variance per worker increased: ambitious workers would produce more
E) Self-selection: able and ambitious workers were attracted to the job, while the lazy workers who left were replaced by more able FTEs. This “sorting” led the average ability in the firm to increase
All observations are correct
Following the Safelite study by Lazear, it would be expected that piece rates is a strictly a superior type of incentive relative to fixed rates
TRUE/FALSE
FALSE:
Piece rates are only efficient when output is easily measured, leaving little (no) room for uncertainty in measuring A’s effort.
In addition: piece rates makes more sense for individual tasks, since effort level of each group member is more difficult to monitor
