Problem Set 3 -- Due May 21, 1997

1. Define quasi-rents. Provide a real-world example of a situation where quasi-rents exist. Under what circumstances would the quasi-rents in your example be appropriable, and what incentive problems might this cause?

2. Attached find materials describing the new compensation program in place at J.B. Hunt, one of the largest for-hire trucking companies in America. Attached also is a press release describing what has happened since the new compensation program went in place.

Several pieces of information will be useful to you. First, the two biggest variable cost items on trucking firms' balance sheets are labor and fuel. Second, "OTR" stands for "on the road" and the pay scale is in cents per mile, where mileage is defined by the shortest distance between drivers' origin and destination. Third, the "current random OTR" was their former pay scale -- one that was about the same as most other trucking firms. "2/25/97 Random OTR" is the new pay scale. Fourth, trucking firms have been under increased pressure from shippers and receivers to pick up and deliver loads on tighter schedules.

Different elements of this compensation program can be explained using several different theories we have come across in class.

What are J.B. Hunt's objectives? What are individual drivers' objectives? How do they conflict?

What choices that drivers make influence the extent to which J.B. Hunt achieves its objectives?

Describe the most important elements in the compensation program as you see it. How do they align drivers' incentives with those of their firm? Is J.B. Hunt using explicit performance incentives? Is it using efficiency wages to provide incentives?

Do the different elements of this compensation program complement each other? Why or why not? Do you see any specific problems with this plan? If so, what are they?

When answering these questions, feel free to make any additional assumptions not in the article or the problem, but state them clearly.

3. According to Hart, what defines a firm? Using Hart's theory, explain why GM faced a hold-up problem with Fisher Auto Body during the 1920s, even though GM owned 60% of Fisher's shares. Also using Hart's theory, explain how vertical integration between GM and Fisher alleviated this incentive problem.

4. Recently, franchisees have brought suit against franchisors, claiming that contractual provisions which limit who they can purchase inputs from are unfair trade practices. Provide an efficiency explanation for such practices. Suppose Congress passes a law prohibiting such provisions in all new franchisor/franchisee contracts. How would you expect contracts between franchisors and franchisees to change as a result? That is, what other contractual provisions would you expect to change?