Managerial Economics & Organizational Architecture 6th Edition by James Brickley , Clifford Smith ,Jerold Zimmerman

Exercise 20

An organizational consultant does not like the way your company compensates profit center managers (currently a large part of their pay is based on the center's profits). He argues that you should compensate the managers based on whether or not they made "reasonable decisions" and not based on the outcome of the decisions, which is partly beyond the control of the managers. The consultant argues that the managers will then have incentives to make good decisions but will not be subject to undue levels of risk. Evaluate this argument.