Question 1

A technique for dealing with the principal-agent problem is to:

Accepted Answer

A)  require managers to purchase shares of stock in the firm. 
B)  establish a profit-sharing plan for managers. 
C)  establish year-end bonuses based on the profits of the firm. 
D)  all the above. 
E)  none of the above. 
A)  require managers to purchase shares of stock in the firm. 
B)  establish a profit-sharing plan for managers. 
C)  establish year-end bonuses based on the profits of the firm. 
D)  all the above. 
E)  none of the above. D

Question 2

Consider this decision tree,which represents the outcomes of two alternative projects that Ink Inc.,a producer of printers,might pursue.Ink Inc.,needs to borrow $1,000 to pursue either project and is going to sell bonds to finance the venture.  
Ink,Inc.,is carrying a large amount of debt because of overexpansion during the dot-com explosion.Under these circumstances,the shareholders would tend to choose:

Accepted Answer

A)  project A, because it has the highest expected value. 
B)  project B, because it has the greatest degree of risk. 
C)  project A, because it has the lowest degree of risk. 
D)  neither project A nor B, because both are risky. 
E)  either project A or B; both have the same degree of risk. 
A)  project A, because it has the highest expected value. 
B)  project B, because it has the greatest degree of risk. 
C)  project A, because it has the lowest degree of risk. 
D)  neither project A nor B, because both are risky. 
E)  either project A or B; both have the same degree of risk. B

Question 3

A manager has a utility function U = C 0.5 if she doesn't work hard and U = C 0.5 - 3 if she does.Expected profit will increase from 1,000 to 1,500 if she works hard.The manager receives compensation C equal to 144 plus a portion x of any profit in excess of 1,000.What is the value of x that will make the manager indifferent between shirking and working hard?

Accepted Answer

A)  0.09. 
B)  0.105. 
C)  0.19. 
D)  0.162. 
E)  None of the above. 
A)  0.09. 
B)  0.105. 
C)  0.19. 
D)  0.162. 
E)  None of the above. D

Question 4

Principal-agent problems can exist between:

Accepted Answer

A)  workers and managers. 
B)  workers and owners. 
C)  workers and customers. 
D)  owners and customers. 
E)  all the above. 
A)  workers and managers. 
B)  workers and owners. 
C)  workers and customers. 
D)  owners and customers. 
E)  all the above.

Question 5

Consider this decision tree,which represents the outcomes of two alternative projects that Ink,Inc.,a producer of printers,might pursue.Ink,Inc.,needs to borrow $1,000 to pursue either project and is going to sell bonds to finance the venture.  
Under these circumstances,bondholders and shareholders may have incompatible incentives because:

Accepted Answer

A)  shareholders know that they have limited liability because of their ability to declare bankruptcy. 
B)  bondholders are not profit maximizers. 
C)  shareholders are not profit maximizers. 
D)  bondholders have limited liability because insurance against risk is provided by the federal government. 
E)  shareholders insure bondholders against risk. 
A)  shareholders know that they have limited liability because of their ability to declare bankruptcy. 
B)  bondholders are not profit maximizers. 
C)  shareholders are not profit maximizers. 
D)  bondholders have limited liability because insurance against risk is provided by the federal government. 
E)  shareholders insure bondholders against risk.

Question 6

A manager has a utility function U = C 0.5 if she doesn't work hard and U = C 0.5 - 1 if she does.Expected profit will increase from 1,500 to 1,600 if she works hard.The manager receives compensation C equal to 81 plus a portion x of any profit in excess of 1,500.What is the value of x that will make the manager indifferent between shirking and working hard?

Accepted Answer

A)  0.09. 
B)  0.105. 
C)  0.19. 
D)  0.242. 
E)  None of the above. 
A)  0.09. 
B)  0.105. 
C)  0.19. 
D)  0.242. 
E)  None of the above.

Question 7

Incentive-compatible employment contracts exist when:

Accepted Answer

A)  the firm and workers have the same objective. 
B)  owners and managers have the same level of income. 
C)  incentives of owners and managers are compatible with, though not necessarily the same as, one another. 
D)  owners and managers have the same objectives as consumers of the products they produce. 
E)  base pay for managers is equal to the profit share they realize. 
A)  the firm and workers have the same objective. 
B)  owners and managers have the same level of income. 
C)  incentives of owners and managers are compatible with, though not necessarily the same as, one another. 
D)  owners and managers have the same objectives as consumers of the products they produce. 
E)  base pay for managers is equal to the profit share they realize.

Question 8

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Accepted Answer

A)  a flat salary alone. 
B)  a flat salary plus some return to estimates of effort. 
C)  only a profit share. 
D)  a flat salary plus a profit share related only indirectly to individual effort. 
E)  a flat salary plus a profit share that is equal to the share accruing to owners. 
A)  a flat salary alone. 
B)  a flat salary plus some return to estimates of effort. 
C)  only a profit share. 
D)  a flat salary plus a profit share related only indirectly to individual effort. 
E)  a flat salary plus a profit share that is equal to the share accruing to owners.

Question 9

Firms can avoid or limit the asset substitution problem by:

Accepted Answer

A)  funding with equity. 
B)  establishing a reputation for protecting creditors. 
C)  insuring bondholders against risk. 
D)  applying to the government for insurance for bondholders. 
E)  a, b, and c. 
A)  funding with equity. 
B)  establishing a reputation for protecting creditors. 
C)  insuring bondholders against risk. 
D)  applying to the government for insurance for bondholders. 
E)  a, b, and c.

Question 10

Creditors and shareholders may have an incentive incompatibility because:

Accepted Answer

A)  shareholders can declare bankruptcy and hence have limited liability. 
B)  creditors must bear less risk than shareholders. 
C)  creditors can call debt if better opportunities arise. 
D)  shareholders choose projects with less risk than creditors would like. 
E)  none of the above; creditors and shareholders are both interested in maximizing the profits of the enterprise. 
A)  shareholders can declare bankruptcy and hence have limited liability. 
B)  creditors must bear less risk than shareholders. 
C)  creditors can call debt if better opportunities arise. 
D)  shareholders choose projects with less risk than creditors would like. 
E)  none of the above; creditors and shareholders are both interested in maximizing the profits of the enterprise.

Question 11

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2,
Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

Accepted Answer

A)  maximum effort, because working hard is important to her. 
B)  maximum effort, because she is afraid of getting fired. 
C)  minimum effort, because she knows she will get fired under any circumstances. 
D)  minimum effort, because her utility decreases as effort increases. 
E)  maximum effort, because she can increase her salary by working harder. 
A)  maximum effort, because working hard is important to her. 
B)  maximum effort, because she is afraid of getting fired. 
C)  minimum effort, because she knows she will get fired under any circumstances. 
D)  minimum effort, because her utility decreases as effort increases. 
E)  maximum effort, because she can increase her salary by working harder.

Question 12

In recent years,individuals and state governments have sued various tobacco companies to compensate for illness and injury allegedly caused by cigarette smoking.Courts have awarded millions of dollars to victims in these cases.This product liability law:

Accepted Answer

A)  encourages firms to ignore safety issues when developing products. 
B)  creates an incentive incompatibility between producers and consumers. 
C)  encourages incentive compatibility between producers and consumers. 
D)  is the only way to achieve compatible incentives when consumer safety is at issue. 
E)  forces firms to declare bankruptcy and to default on bondholders. 
A)  encourages firms to ignore safety issues when developing products. 
B)  creates an incentive incompatibility between producers and consumers. 
C)  encourages incentive compatibility between producers and consumers. 
D)  is the only way to achieve compatible incentives when consumer safety is at issue. 
E)  forces firms to declare bankruptcy and to default on bondholders.

Question 13

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Accepted Answer

A)  profit shares. 
B)  increased nonmonetary benefits. 
C)  increased fixed salary. 
D)  decreased effort requirements. 
E)  increased future compensation in the form of retirement pay. 
A)  profit shares. 
B)  increased nonmonetary benefits. 
C)  increased fixed salary. 
D)  decreased effort requirements. 
E)  increased future compensation in the form of retirement pay.

Question 14

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

Accepted Answer

A)  an adverse-selection problem. 
B)  a moral-hazard problem. 
C)  coinsurance. 
D)  signaling. 
E)  all the above. 
A)  an adverse-selection problem. 
B)  a moral-hazard problem. 
C)  coinsurance. 
D)  signaling. 
E)  all the above.

Question 15

Use the following profit function (per worker)for the Blue Delta Faucet Company to answer this question. P(e)= 40e - (2e2 + 100)
Note that P = firm profits and e = worker-hours per day.Assume that effort is observed perfectly.At the profit-maximizing level of effort for the firm,daily per-worker compensation will be:

Accepted Answer

A)  $100. 
B)  $200. 
C)  $300. 
D)  $340. 
E)  none of the above. 
A)  $100. 
B)  $200. 
C)  $300. 
D)  $340. 
E)  none of the above.

Question 16

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Accepted Answer

A)  government insurance encouraged bank managers to take on more risk than they would have without such insurance. 
B)  bank managers no longer attempted to maximize the profits of the firm. 
C)  insurance attracted depositors who would not have used banks otherwise. 
D)  depositors had more information about the banks than shareholders had. 
E)  government insurance encouraged bank managers to take on less risk than they would have without such insurance. 
A)  government insurance encouraged bank managers to take on more risk than they would have without such insurance. 
B)  bank managers no longer attempted to maximize the profits of the firm. 
C)  insurance attracted depositors who would not have used banks otherwise. 
D)  depositors had more information about the banks than shareholders had. 
E)  government insurance encouraged bank managers to take on less risk than they would have without such insurance.

Question 17

Use the following profit function (per worker)for the Blue Delta Faucet Company to answer this question. P(e)= 40e - (2e2 + 100)
Note that P = firm profits and e = worker-hours per day.Assume that effort is observed perfectly.At this profit-maximizing level of effort for the firm,profits per worker will be:

Accepted Answer

A)  $40. 
B)  $100. 
C)  $300. 
D)  $400. 
E)  none of the above. 
A)  $40. 
B)  $100. 
C)  $300. 
D)  $400. 
E)  none of the above.

Question 18

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2,
Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Accepted Answer

A)  2E2. 
B)  -2E. 
C)  100. 
D)  -4E. 
E)  none of the above. 
A)  2E2. 
B)  -2E. 
C)  100. 
D)  -4E. 
E)  none of the above.

Question 19

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2,
Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

Accepted Answer

A)  100. 
B)  -28. 
C)  -128. 
D)  228. 
E)  none of the above. 
A)  100. 
B)  -28. 
C)  -128. 
D)  228. 
E)  none of the above.

Question 20

Donald has a beach house on the Outer Banks of North Carolina that was severely damaged in the most recent hurricane to strike the coast.Due to beach erosion,he has rebuilt twice in the past 20 years.He is intent on rebuilding,confident that government-provided flood insurance will cover his expenses.This is an example of:

Accepted Answer

A)  how market-based solutions to problems are superior to government solutions. 
B)  moral hazard. 
C)  adverse selection. 
D)  asset substitution. 
E)  none of the above. 
A)  how market-based solutions to problems are superior to government solutions. 
B)  moral hazard. 
C)  adverse selection. 
D)  asset substitution. 
E)  none of the above.

A technique for dealing with the principal-agent problem is to:

Principal-agent problems can exist between:

Incentive-compatible employment contracts exist when:

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Firms can avoid or limit the asset substitution problem by:

Creditors and shareholders may have an incentive incompatibility because:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

In recent years,individuals and state governments have sued various tobacco companies to compensate for illness and injury allegedly caused by cigarette smoking.Courts have awarded millions of dollars to victims in these cases.This product liability law:

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

Introduction

Demand Theory

Consumer Behavior and Rational Choice

Estimating Demand Functions

Production Theory

The Analysis of Costs

Perfect Competition

Monopoly and Monopolistic Competition

Managerial Use of Price Discrimination

Bundling and Intrafirm Pricing

Oligopoly

Game Theory

Auctions

Risk Analysis

Adverse Selection

Government and Business

Optimization Techniques

Appendix Problems

Filters

Exam 15: Principalagent Issues and Managerial Compensation

A technique for dealing with the principal-agent problem is to:

Principal-agent problems can exist between:

Incentive-compatible employment contracts exist when:

Optimal employment contracts for managers,given revenue risk and unobservable output,consist of:

Firms can avoid or limit the asset substitution problem by:

Creditors and shareholders may have an incentive incompatibility because:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

In recent years,individuals and state governments have sued various tobacco companies to compensate for illness and injury allegedly caused by cigarette smoking.Courts have awarded millions of dollars to victims in these cases.This product liability law:

If effort is unobservable and revenues are riskless,firms can design incentive-compatible compensation schemes by offering workers:

Consider Mr.Ed,who purchases an insurance policy on a thoroughbred that he has acquired.He then proceeds to run the horse even though the horse has tendinitis.This is an example of:

The savings and loan crisis of the early 1990s was caused by a moral-hazard problem because:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E2, Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be:

Introduction

Demand Theory

Consumer Behavior and Rational Choice

Estimating Demand Functions

Production Theory

The Analysis of Costs

Perfect Competition

Monopoly and Monopolistic Competition

Managerial Use of Price Discrimination

Bundling and Intrafirm Pricing

Oligopoly

Game Theory

Auctions

Risk Analysis

Adverse Selection

Government and Business

Optimization Techniques

Appendix Problems

Filters

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.Given her utility function,Wilma has an incentive to supply:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.The marginal utility of effort for Wilma is:

Suppose that Wilma's utility function is given by U(E)= 100 - 2E², Where E = Wilma's work effort in producing homemade dinners,measured in hours per day.If Wilma is forced to work an 8-hour day producing homemade dinners,her total utility will be: