You wish to hire Ricky to manage your Dallas operations. The profits from the op

Question

You wish to hire Ricky to manage your Dallas operations. The profits from the operations depend

partially on how hard Ricky works, as follows:

Probabilities

Profit = $10,000

Profit = $50,000

Lazy Worker

60%

40%

Hard Worker

20%

80%

If Ricky is lazy, he will surf the Internet all day, and he views this as a zero cost opportunity.

However, Ricky would view working hard as a “personal cost” valued at $1,000. What fixedpercentage

of the profits should you offer Ricky? Assume Ricky only cares about his expected

payment less any “personal cost.”

Comment

Probabilities

Profit = $10,000

Profit = $50,000

Lazy Worker

60%

40%

Hard Worker

20%

80%

Explanation / Answer

Answer is:

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.

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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