24. You wish to hire Ron to manage your Dallas operations. The profits from the

Question

24.  You wish to hire Ron to manage your Dallas operations.  The profits from the operations depend partially on how hard Ron works, as follows.  Probabilities:

Profit = $10,000   Profit=$50,000

Lazy 60%                                 40%

Hard worker 20%                   80%

If Ron is lazy, he will surf the Internet all day, and he views this as a zero cost opportunity.  However, Ron would view working hard as a "personal cost" valued at $1000.  What fixed percentage of the profits should you offer Ron?  Assume Ron cares only about his expected payment less than any "personal cost."

Explanation / Answer

You can see that offering a 6.25% to Ron would make his Net gains same in both the scenarios whether he is lazy or hard working and offering 6.25% would increase the Company's gains in scenario 2 where Ron is hard working.

So, the company should offer him a fixed 6.25% of the profits.

Scenario1 Scenario2 Expected profit Profit $ 10,000 $ 50,000 Scenario 1 Lazy 60% 40% $ 26,000 Scenario 2 Hard work 20% 80% $ 42,000 Gains to Ron 6.25% fixed share Personal cost Net gain Scenario 1 $ 1,625 $- $ 1,625 Scenario 2 $ 2,625 $ 1,000 $ 1,625 Gains to company Profit Offered to ron Net profit Scenario 1 $ 26,000 $ 1,625 $ 24,375 Scenario 2 $ 42,000 $ 2,625 $ 39,375

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