Exam 15: Incentive Compensation

The DuPont case is a good example of an incentive package gone awry. In review, it placed a portion of employee's pay into an "at-risk pool." If the division had exceeded expectations, the employees would have received a bonus from the pool. How would a "relative performance contract" have saved the DuPont bonus system?

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Question 1

Correct Answer:

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DuPont could have benchmarked its division's profits against performance by other firms in other relevant markets. However, there are several relevant markets, e.g. housing, automobiles, apparel. It would be tricky to assign weights to those markets. Another option would have been to judge the division relative to other DuPont divisions. Poor overall economic performance would also affect some other divisions. The problem with this plan is that some divisions would be harder hit than others, depending which sectors were hit hardest by the recession and by high input prices. The advantage is that the employees would not likely have been faced with significant financial losses.

When employees are offered incentives to find new customers, but the aggregate economy is so weak (in recession) that the firm loses consumers, then the incentive plan:

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Question 2

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There is scientific evidence to suggest that:

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Question 3

Correct Answer:

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Dan Heath is the owner of Plain Truth Advertising. He is attempting to design salary systems for his employees, most of whom are sales agents. To get a good system, he needs to recognize the trade-offs between:

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Question 4

Economists believe the free rider problem is very important in complex business organizational structures. Still, businesses continue to build teams to solve problems or to deliver products to consumers. Often special rewards or bonuses are provided to the team rather than to the individuals on the team. Write a brief essay that either defends the economists' concern or explain why economists are wrong on this issue.

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Question 5

Since the1980s, the compensation of CEOs in large corporations has been increasingly tied to performance of the common stock of the company. Research now indicates that if the value of the firm changes by $1,000, the wealth of CEO changes by:

(Multiple Choice)

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Question 6

Consider the salary of Mary Sue Nelson, a sales agent for Plain Truth Advertising. Her wage package is W = 1,000 + .4Q, where Q is her dollar volume of sales. Her productivity is Q = 200e + , where e denotes her hours of effort and m is a random variable with mean 0. She has an effort cost of C = e². Under this contract, her choice of effort will be:

(Multiple Choice)

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Question 7

Team production is a limiting factor as a solution to incentive problems since:

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Question 8

Three difficulties that limit the usefulness of ownership in resolving incentive problems are:

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Question 9

An efficient allocation of risk among employees and owners must:

(Multiple Choice)

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Question 10

A compensation program that includes all performance indicators that influence an employee's output is called the:

(Multiple Choice)

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Question 11

The informativeness principle tells us that:

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Question 12

Why do many firms base incentive pay on group performance?

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Question 13

Consider the salary of Mary Sue Nelson, a sales agent for Plain Truth Advertising. Her wage package is W = 1,000 + .4Q, where Q is her dollar volume of sales. Her productivity is Q = 200e + , where e denotes her hours of effort and m is a random variable with mean 0. She has an effort cost of C = e² . Under this contract, the expected value of her total wages will be:

(Multiple Choice)

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Question 14

Incentives would not be a problem:

(Multiple Choice)

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Question 15

To qualify as incentive pay, a performance-based compensation program:

(Multiple Choice)

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Question 16

If all issues of effort, output, and pay are fully observable and contactable between an owner and an employee, then:

(Multiple Choice)

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Question 17

One possible solution to an incentive problem arising under unobservable actions is:

(Multiple Choice)

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Question 18

What are the factors that favor high incentive pay for an employee? Explain which of the five factors is the most important.

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Question 19

Incentives would not be a problem if:

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Question 20

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When employees are offered incentives to find new customers, but the aggregate economy is so weak (in recession) that the firm loses consumers, then the incentive plan:

There is scientific evidence to suggest that:

Dan Heath is the owner of Plain Truth Advertising. He is attempting to design salary systems for his employees, most of whom are sales agents. To get a good system, he needs to recognize the trade-offs between:

Since the1980s, the compensation of CEOs in large corporations has been increasingly tied to performance of the common stock of the company. Research now indicates that if the value of the firm changes by $1,000, the wealth of CEO changes by:

Team production is a limiting factor as a solution to incentive problems since:

Three difficulties that limit the usefulness of ownership in resolving incentive problems are:

An efficient allocation of risk among employees and owners must:

A compensation program that includes all performance indicators that influence an employee's output is called the:

The informativeness principle tells us that:

Why do many firms base incentive pay on group performance?

Incentives would not be a problem:

To qualify as incentive pay, a performance-based compensation program:

If all issues of effort, output, and pay are fully observable and contactable between an owner and an employee, then:

One possible solution to an incentive problem arising under unobservable actions is:

What are the factors that favor high incentive pay for an employee? Explain which of the five factors is the most important.

Incentives would not be a problem if:

Introduction

Economists View of Behavior

Markets, Organizations, and the Role of Knowledge

Demand

Production and Cost

Market Structure

Pricing With Market Power

Economics of Strategy: Creating and Capturing Value

Economics of Strategy: Game Theory

Incentive Conflicts and Contracts

Organizational Architecture

Decision Rights: The Level of Empowerment

Decision Rights: Bundling Tasks Into Jobs and Subunits

Attracting and Retaining Qualified Employees

Individual Performance Evaluation

Divisional Performance Evaluation

Corporate Governance

Vertical Integration and Outsourcing

Leadership: Motivating Change Within Organizations

Understanding the Business Environment: The Economics of Regulation

Ethics and Organizational Architecture

Organizational Architecture and the Process of Management Innovation

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