James' small business has grown and he is looking to hire you as a full-time manager....

 

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James' small business has grown and he is looking to hire you as a full-time manager. In the past, when James has worked hard at managing the business the net income before manager compensation was $300,000 85% of the time and only $135,000 15% of the time. The reverse is true when James has not worked hard (i.e., net income is $300,000 only 15% of the time and $135,000 85% of the time). James expects the same outcomes with the new manager as well. You are both risk and effort adverse, with your utility equal to the square root of your compensation. Your disutility for work is 120 if you work hard and 90 if you do not work hard (i.e., shirk). You also have a reservation utility of 160. James offers a salary of $60,000 plus 10% of net income for the year to you if you accept the manager position. Required a. Will you accept the job and will you work hard? (Show calculations) (3 marks) b. Now assume that after three years your contract term is up and James wants to renegotiate with you. He proposes a salary of $10,000 plus 25% of net income. Will you accept and will you work hard? (Show calculations) (4 marks) c. Assuming that you accept and work hard under the new contract proposed in b (that is not necessarily the correct response for b but please assume that for part c), is James' expected utility higher or lower as compared to under the original contract? James is risk neutral with the amount of profit after manager compensation is his utility. (Show calculations) (3 marks) James' small business has grown and he is looking to hire you as a full-time manager. In the past, when James has worked hard at managing the business the net income before manager compensation was $300,000 85% of the time and only $135,000 15% of the time. The reverse is true when James has not worked hard (i.e., net income is $300,000 only 15% of the time and $135,000 85% of the time). James expects the same outcomes with the new manager as well. You are both risk and effort adverse, with your utility equal to the square root of your compensation. Your disutility for work is 120 if you work hard and 90 if you do not work hard (i.e., shirk). You also have a reservation utility of 160. James offers a salary of $60,000 plus 10% of net income for the year to you if you accept the manager position. Required a. Will you accept the job and will you work hard? (Show calculations) (3 marks) b. Now assume that after three years your contract term is up and James wants to renegotiate with you. He proposes a salary of $10,000 plus 25% of net income. Will you accept and will you work hard? (Show calculations) (4 marks) c. Assuming that you accept and work hard under the new contract proposed in b (that is not necessarily the correct response for b but please assume that for part c), is James' expected utility higher or lower as compared to under the original contract? James is risk neutral with the amount of profit after manager compensation is his utility. (Show calculations) (3 marks)

Answer rating: 100% (QA)

To determine whether you will accept the job and work hard we can compare the expected utilities under different scenarios Lets start with the origina... View the full answer