Anika is hired by the owner of a kitchen supply store to manage the store. Anika and the owner are both risk neutral. The probability of weak demand is 0.2 and the probability of strong demand is 0.8. Each cell in the following table shows the store€™s profit from a specific combination of demand and Anika€™s managerial effort. Anika€™s cost of effort isnot subtracted from these profits. This effort cost is 2 for low effort, 10 for medium, and 32 for high.

Create a spreadsheet containing this information. Add a column showing Anika€™s cost of effort and also add columns for the expected payoff to Anika and the owner. 

a. Fill in the expected payoffs to both parties if Anika is compensated with a profit-sharing contract providing her with 50% of the profits (and the owner gets the other 50%). Which effort level does Anika choose?

b. Now suppose that Anika€™s contract provides her with a base salary of 30 and 100% of any profits exceeding 100. Which effort level does she choose?

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Weak Demand Strong Demand Low Effort 40 60 Medium Effort 60 100 High Effort 140 100