As chairman of the board of ASP Industries, you estimate that your annual profit is given by the table below. Profit (() is conditional upon market demand and the effort of your new CEO. The probabilities of each demand condition occurring are also shown in the table.

You must design a compensation package for the CEO that will maximize the firm€™s expected profit. While the firm is risk neutral, the CEO is risk averse. The CEO€™s utility function is
Utility  W0.5 when making low effort
Utility  W0.5  100 when making high effort
Where W is the CEO€™s income. (The €“100 is the €œutility cost€ to the CEO of making a high effort.) You know the CEO€™s utility function, and both you and the CEO know all of the information in the preceding table. You do not know the level of the CEO€™s effort at time of compensation or the exact state of demand. You do see the firm€™s profit, however.
Of the three alternative compensation packages below, which do you as chairman of ASP Industries prefer? Why?
Package 1: Pay the CEO a flat salary of $575,000 per year
Package 2: Pay the CEO a fixed 6% of yearly firm profits
Package 3: Pay the CEO a flat salary of $500,000 per year and then 50% of any profits above $15 million

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Market Demand Market Probabilities Low Effort High Effort Low Demand 0.40 11-$10million 11 $10million 11 $15million 11 $17million Eigh Demand 0.30 11-$15million 0.30 $ pe 5 million