Woodhaven Service is a small, independent gas station located in the Woodhaven section of Queens. The station has three gasoline pumps and two service bays. The repair facility specializes in automotive maintenance (oil changes, tune- ups, etc.) and minor repairs (mufflers, shock absorbers, etc.). Woodhaven generally refers customers who require major work such as transmission rebuilds and electronics to shops that are better equipped to handle such repairs. Major repairs are done in- house only when both the customer and mechanic agree that this is the best course of action. During the 20 years that he has owned Woodhaven Service, Harold Mateen’s competence and fairness have built a loyal customer base of neighborhood residents. In fact, demand for his services has been more than he can reasonably meet, yet the repair end of his business is not especially profitable. Most of his competitors earn the lion’s share of their profits through repairs, but Harold is making al-most all of his money by selling gasoline. If he could make more money on repairs, Woodhaven would
a. This case presents some popular approaches to alleviating agency costs. Although certain aspects of each of these methods are consistent with the views presented in the text, none of these methods is likely to succeed. Discuss the similarities and differences between the ideas of the chapter and
(i) Dr. Weisbrotten’s approach.
(ii) Harold Mateen’s idea of hiring “ harder- working” mechanics.
b. Discuss the expected general effect on agency costs at Woodhaven Service of the new incentive compensation plans. How might they help Woodhaven? Assuming that Harold wants his business to be successful for a long time to come, what major divergent behaviors would be expected under the new compensation proposals? How damaging would you expect these new behaviors to be to a business such as Woodhaven Service? Also, present a defense of the following propositions:
(i) Harold’s plan offers less incentive for divergent behavior than Honest Jack’s.
(ii) Limiting a mechanic’s pay by placing an upper bound of $ 750 per week on his or her earnings reduces the incentive for divergent behavior.
c. Suppose Harold owned a large auto repair franchise located in a department store in a popular suburban shopping mall. Suppose also that this department store is a heavily promoted, well- known national chain that is famous for its good values and easy credit. How should Harold’s thinking on incentive compensation change? What if Harold did not own the franchise but was only the manager of a company- owned outlet?
d. In this problem, it is assumed that knowledge and decision rights are linked. The mechanic who services the car decides what services are warranted. Discuss the costs and benefits of this fact for Woodhaven Service and the independently owned chain- store repair shop.
e. Suppose that Woodhaven’s problems are not due to agency costs. Briefly describe a likely problem that is apparent from the background description in this problem.