Consider the following change to Angelo’s situation in the Managerial Solution. Now Angelo can provide loans to only one of the two groups. If he loans to the safer group, he gets his 10% in Year 1 and faces the same choice in Year 2 with two new groups of borrowers. If he loans to the risker group, he gets 10% but will be fired in the second year and earns nothing when the risky loans start to go bad. If Angelo wants to maximize his earnings over the two years (ignoring discounting), what will he do in each year? Would his firm gain by using a system of deferred compensation?
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