A Risk-Averse Manager Is Hired to Run a Firm for Shareholders

question 6

Multiple Choice

A risk-averse manager is hired to run a firm for shareholders. If shareholders cannot observe the manager's effort,which would be the best employment contract?

• A)a high-powered incentive contract to elicit maximum effort.
• B)a fixed salary.
• C)a moderately powered incentive scheme that elicits some effort without exposing the manager to too much risk.
• D)an incentive scheme that provides maximum incentives and maximum insurance.

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Definitions:

Marginal Cost

The supplementary expense associated with creating an additional unit of a product or service.

Principal-Agent Problem

A scenario in which there is a conflict of interest between a party that delegates work (principal) and the party that performs the work (agent).

Corporations

Legal entities that are separate from their owners, with the ability to own assets, incur liabilities, and engage in contracts or legal actions.

Corporate Managers

Individuals in charge of managing a corporation's affairs, making strategic decisions, and ensuring operational efficiency.