Assume the operations manager at the company you own prefers to put in low effort rather than high effort. In order the manager to exert high effort, his expected financial gain must be at least $60,000 higher than if he puts in low effort. You are evaluating three possible compensation packages:
A flat salary of $300,000
A payment equal to 5% of the expected profits from the profit center
A flat payment of $200,000 plus 5% of any profits over $10 million.
a. Discuss the effects of each of the compensation packages on company profits and the behavior of the manager. What assumptions are needed in order to compare the expected values and risks associated with each option?
b. How would a risk averse versus a risk neutral manager view the different compensation packages?