Monitoring, Management Compensation

Question 1

Relationship between managers and owners empirically

Answer 1

Hard to measure

Question 2

What happens if managers goals do not align to those of owners

Answer 2

Owners need to provide incentives to exert high effort (principle agent problem)

Question 3

Set up for principle agent model
Principal is restaurant owner
Agent is waiter
If waiter does not exert hard effort, customers may not return and revenues fall. They dont care

First owner writes contract with waiter compensation based on revenue observed. Waiter decides to accept or not, and if accepts, choose what effort to exert ( 2 levels of effort)

What is reservation utility

Answer 3

Utility if he does not accept (10 in this instance, from going to work at another place)

Question 4

So what is waiters utility function

Answer 4

U= w - e (If he devotes a effort level e)
Or
U = 10 ( working at another place)

Question 5

What is principals revenue expression

Answer 5

R(e) (revenue is a function of effort)

R(e) = H (high if e=2 i.e the high level effort)
Or
R(e) = L (if e=0, low effort)

Question 6

So what do owners offer waiter if want revenue high vs low

Answer 6

Wh is revenue high
Wl if revenue low

Question 7

Agent’s participation constraint

Answer 7

U = W - e
Wh - 2 >= 10

I.e utility from high wage >= utility from low wage

Question 8

Agent incentive constraint

Answer 8

Wh - 2 >= Wl - 0

Question 9

Equality case