Chapter 10: Incentive Conflicts and Contracts
OPENING A NEW RESTAURANT
Discussion Question Answers:
1. Restaurant owners have a strong interest in the restaurant’s profitability and value. Owners
get to keep the profits and naturally want them to be high. Profits are equal to total revenue
minus total costs. Thus owners have an incentive to increase top line revenue and to reduce costs
without sacrificing quality. They care about both current and future profits and thus are
concerned about their restaurants’ reputation, which likely affects future profits. Managers are
2. Your existing restaurants are close to your office and you spend significant time with the
managers. It is relatively easy for you to observe if they are on the job, exerting effort, and
managing the restaurants effectively. With five restaurants in Portland you can easily benchmark
the costs and revenues of each to the others to help identify any opportunism by the managers.
3. In Portland you hire the managers as employees and provide them with essentially fixed
salaries. This contract is unlikely to be optimal in Salt Lake. You will not be able to control the
incentive problems well with direct monitoring as you do in Portland. It is important to provide
the Salt Lake manager with increased incentives to care about the profitability and success of the
restaurant. You might want to pay the manager a lower base salary and to provide a larger annual
bonus contingent on performance (e.g., based on the restaurant’s profitability). It might also want
the new manager to make an equity investment to provide even greater incentives to care about
EBAY.COM
Discussion Question Answers:
1. eBay creates value by lowering transaction costs. It has helped create an electronic market
2. eBay promises potential users certain services and guarantees. One set of potential contracting
problems relates to eBay defaulting on these guarantees. The second set of potential contracting
3. eBay has invested substantially to build its reputation as the leading Internet auction site. This
investment helps assure that it will provide high quality services to customers. If eBay does not,
The Feedback Forum is a place where eBay users leave comments about each other’s buying and
selling experiences. If you’re a bidder, you can easily check the seller’s Feedback Profile before
you place a bid to learn about the other person’s reputation with previous buyers. If you’re a
Participants sign user agreements that specify the trading rules and expectations. The safety staff
4. There are out-of-pocket expenses to fund the various activities listed above. There is also a
5. It is unclear whether or not they are investing optimally. Given the costs of fraud to eBay, it is
likely to be optimal to spend significant resources to curtail it. Generally, however, it does not