9781118041581

Summary 623

that MWin cell E17 is equal to zero.) Does this optimal contract

carry a strong or weak profit incentive?

d. If e were observable, then the parties could write a forcing contract with

a fixed wage (b 0) payable as long as the worker delivers an optimal

level of effort. What level of effort maximizes total profit? Compare the

total profits attained in this case with the profits in part (c).

AB C D EF

1

2 AN OPTIMAL INCENTIVE CONTRACT

3

4 Fixed Profit Worker’s Expected

5 Wage (W) Share (b) Effort Gross Profit

6

7 10,000 0.30 30 30,000

8

9 Expected Worker’s Worker’s Risk-adjusted

10 Compensation Risk Premium Disutility Profit

11

12 19,000 900 9,000 9,100

13

14 Employer’s Total Worker’s

15 Profit Profit Marginal Profit

16

17 11,000 20,100  300

18

Suggested References

The following articles are some of the classic treatments of asymmetric information, principal-agent problems,

and organizational design.

Akerlof, G. “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism.” Quar-

terly Journal of Economics(1970): 488–500.

Brynjolfsson, E., and L. M. Hitt. “Beyond Computation: Information Technology, Organizational

Transformation, and Business Performance.” Journal of Economic Perspectives(2000): 23–48.

Coase, R. “The Nature of the Firm.” Economica(1937): 386–405.

Jensen, M. C., and W. Meckling. “Theory of the Firm: Managerial Behavior, Agency Costs and Own-

ership Structure.” Journal of Financial Economics(1976): 305–360.

Lazear, E. P., and K. L. Shaw. “Personnel Economics: The Economist’s View of Human Resources.”

Journal of Economic Perspectives(Fall 2007): 91–114.

Riley, J. G. “Silver Signals: Twenty-Five Years of Screening and Signalling.” Journal of Economic Lit-

erature(2001): 432–478.

Shleifer, A., and R. W. Vishny. “A Survey of Corporate Governance.” Journal of Finance(1997):

737–783.

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