# Problem Set 2

## Due May 4, 1998

1.    Define "greenmail."  Discuss the role greenmail plays in the market for corporate control.  Be sure to discuss whether it is likely efficiency-enhancing or not, and why.

2.    The compensation packages received by many CEOs and other upper-level managers include stock options.  One example of a stock option would give the holder the right to buy 100 shares of Microsoft stock at a price of \$120/share if exercised before June 1, 1998.  This is valuable because if Microsoft's share price, sitting at about \$95 (as of 4/24/98), were to increase above \$120 before June 1, the holder to exercise the option and turn around and sell the stock at a profit.  The option becomes worthless, however, after June 1.  Until then, all else equal, the option price is an increasing function of the firm's stock price.

[See http://econweb.sscnet.ucla.edu/hubbard/97nobel2.htm for a discussion on option pricing, if you are interested in this kind of stuff.  This is not at all important for the purposes of this class, however.]

In light of some well-publicized, large exercises of options which provided several CEOs (most notably Michael Eisner of Disney) millions of dollars, several commentators have recommended that stock options be used to compensate lower-level employees as well.  Part of the underlying idea is that incentive schemes that work well for CEOs should work well for lower-level employees too.

Comment on this recommendation.  Would paying lower-level employees stock options likely be efficient? Why or why not?  For simplicity, assume that labor markets for such employees are competitive.

3.    The form of truck drivers' compensation differs systematically according to the length of the haul.  Truck drivers who make local deliveries are generally paid fixed wages.  Truck drivers who make long-distance hauls are generally paid by the haul.  Long-haul drivers are generally paid a function of the length of the haul.

Truck drivers receive job assignments from their dispatcher at the start of the day.  They generally telephone in after finishing each haul to receive further instructions.  At this time, dispatchers often change drivers schedules' or add hauls to their schedule.  Local drivers return to their base at the end of the day.  Long-haul drivers generally do not.

• Would you say that short-haul drivers are being paid performance incentives?  Long-haul drivers?  Discuss.
• Assume that compensation schemes in the trucking industry are chosen optimally in the sense we discussed in class.  What is the trade-off firms face when determining how sensitive drivers compensation should be with respect to measures of their performance?
• What are the factors affecting this trade-off in the context of the trucking industry?
• Applying the framework discussed in class, propose a theory which explains why different compensation schemes are used for short- and long-haul drivers.