Problem Set 2
Due April 25, 1997
1. In Jensen and Meckling's piece, debt financing serves
to provide entrepreneur/managers incentives toward non-value-maximizing
In Jensen's piece on takeovers, he asserts that high debt levels can serve
to improve managers incentives.
Is Jensen confused? Write a paragraph or two which reconciles
these two positions, or which explains why they are irreconcilable.
2. What is the winner's curse? How does
this phenomenon affect the market for corporate control? Does it
tend to make this market work better or worse?
3. You are the owner of a small trucking firm in LA.
You employ several similarly risk averse drivers who value both income
and leisure. The firm's output, and thus profit, is a function of
your drivers' effort -- high effort levels mean that your firm is able
to serve more customers because your trucks are on the road and moving
more of the time. Effort, however, is costly to drivers.
Assume that individual truck drivers' output is observable (the number
of "hauls" he makes, how long they are, etc.) to you. Output
is a function of driver effort and of factors outside of his control, such
as traffic. Assume that you can directly observe only output and
Your drivers run two types of routes. One goes back and forth between
West LA and Bakersfield. On the average, there is very little traffic,
and not much difference in the traffic from day to day. The other
goes back and forth between West LA and Pomona. Because it goes through
Downtown LA, this route tends to have a lot of traffic, and a lot of variablility
You are trying to design optimal compensation contracts for drivers on
these different routes. Compensation consists of a fixed wage plus
a per-mile rate. Assume that the market for truck drivers is perfectly
competitive -- truck drivers' utility from working for you is the same
as that in their next best opportunity.
You hook yourself up to the internet. On its website, Caltrans has
a page which offers up to date traffic reports on all major Southern California highways.
This provides a good, but imperfect, signal of the conditions your drivers
Describe how the optimal compensation contract will differ between
the two routes (hint: both the fixed wage and the per-mile rate will differ).
Provide the economic intuition for why it will differ.
Would it be optimal to change how you compensate drivers after you
obtain this capability? If so, how? If not, why not?
4.. Read the following two Wall Street Journal articles about Ben and Jerry's
Homemade, Inc. and answer the following questions.
Company Background. News
a) How are the stated objectives of Ben and Jerry's different than most
b) Considering only the interests of Ben and Jerry's employees and shareholders,
are Ben and Jerry's policies likely to have been
value-maximizing before the firm went public in 1984? After the firm went
c) Discuss Ben and Jerry's management problems since then in light of moral
hazard. Be sure to state within your answer: who the
principal(s) and agent(s) are, how their objectives differ, and on which
types of decisions conflicts of interests arise.