A consulting company’s goal is to maximize “welfare” for their company and workers. It has identified four levels of effort, gross profit outcomes, and probabilities as well as worker disutility levels.

   

The four compensation options are:

Observable fixed wages of $70,000

Unobservable fixed wages of $50,000

Incentives A:($20K + ¼ expected gross profit)

Incentives B:(-$15K + ¾ expected gross profit).

a) Calculate the amounts of expected gross profits and the expected net profits for each effort level and report them. Document the calculated amounts in a table and identify which effort level is optimal for each compensation option.

b) The company has decided that its objective is to maximize what it calls “FAIR MIX” using this formula:

Welfare = (.6) times employer profit plus (.4) worker profit.

For the third compensation option above (Incentives A) calculate the compensation amount, employer profit, worker profit and total profit for compensation options MEDIUM and HIGH.

c.)Explain your findings from part a) and part b) in a short summary report to the Compensation Committee.
 

Transcribed Image Text:

Effort and Profits Table Gross Profits Expected Effort $200K or $75K Gross Profit Disutility Maximum High Medium Low .8 and.2 .7 and.3 .5 and.5 .2 and .8 $175,000 $162,500 $137,500 $100,000 $85,000 $40,000 $36,000 $32,000 Effort and Profits Table Gross Profits Expected Effort $200K or $75K Gross Profit Disutility Maximum High Medium Low .8 and.2 .7 and.3 .5 and.5 .2 and .8 $175,000 $162,500 $137,500 $100,000 $85,000 $40,000 $36,000 $32,000

Answer rating: 100% (QA)

a Option 1 Observable fixed wages of 70000 Expected Gross Profit 200000 Expected Net Profit 130000 O... View the full answer