Chapter 9 Discussion Questions

 

9.1 You are trying to set up the salary scale at your firm where there are two levels of jobs, workers and bosses. All individuals in the firm produce the same thing, coal, and the two jobs are set up merely for reasons of motivation. It is very difficult to count or weigh coal, but when stacked up, it is easy to see which worker's output fills a larger truck. There are two workers who are risk neutral.

  1. What would determine the optimal spread in salaries between the boss and workers?

  2. What is likely to happen if you set a very large spread between the boss and workers?

  3. Under what conditions might a contest like this be optimal instead of using piece rates to encourage effort?

9.2 Propose an explanation to the following regularities in executive compensation:

a. CEO compensation is positively related to market value of the firm.

b. CEO compensation is more variable than production worker compensation.

c. The CEO’s base salary is unrelated to the rate of return on equity.

 

9.3 Consider a firm that has a three-level hierarchy with four positions. At the bottom are two laborer positions. The next level consists of one supervisor. At the top is one CEO. Salaries are given as follows:

CEO = 710

Supervisor = 660

Laborer = 46

Work is performed in two stages. During the first stage, a laborer competes against one other laborer. There are two simultaneous contests in the first round. The two losers take the laborer's wage and go home. The winner of each of the first stage contests enters the second stage. The winner of the second stage becomes CEO and the loser becomes supervisor. Each worker earns his wage only once and after all competition is complete. Those who get promoted to supervisor, compete again for the CEOs job. Note that nothing constrains a worker to exert the same level of effort in each of the two rounds. All four individuals are risk neutral.

  1. What determines the effort that is exerted by the workers in the second round, that is, how much effort do supervisors exert in hopes of becoming CEO?
  2. What determines how much effort is exerted in the first round?

  3. Were workers who ended up being labors happy about going to work for the firm in the first place or would they have been better off elsewhere? Had they not been happy about working for this firm as laborers, why did they sign on initially?

9.4 XYZ international employs 40 marketing associates. It is expected that within a year one of marketing associates will be promoted to the rank of a senior associate. The job responsibilities of the senior associate are exactly the same as those of marketing associates. However, a senior associate has a 25% larger cubical than other marketing people, she also receives a 25% percent greater base salary, a 25 percent bigger desk and even her chair is 25% bigger. In this firm workers are paid straight salary; the only reward for good performance is promotion to the senior associate level. Suppose the worker with most sales by January 31 is promoted. The incentive effects of this tournament are the greatest when:

I. Each worker knows only his sales numbers and does not learn sales of co-workers until January 31.

II. All marketing associates believe that their ability is about the same as the ability of their colleagues.

III. A typical sale is relatively small so that each marketing associate works on hundreds of unrelated sales every year (as opposed to a few very large sales).

The following factors are essential for maximum incentive effects of a tournament:

a. I

b. I and II

c. II

d. I, II and III