Economics 174

Midterm, Spring 1996

There are 50 possible points on this examination. You have 50 minutes. Allocate your time appropriately. At 9:50, the examination will end. You are allowed to work overtime, but at a price of 2 points per minute.

Good luck!

1. (10 pts.) Identify the three components of the agency costs associated with equity financing.

2. (10 pts.) According to Coase, what determines the size and scope of the firm?

3. (10 pts.) "Groupware" computer programs such a Lotus Notes can permit supervisors to better monitor individual workers -- particularly white-collar workers. For example, supervisors can use the software to remotely view the document or spreadsheet file individuals are working on, and watch as individuals type in characters.

Assuming that workers care only about their income and effort levels, and that their preferences exhibit no wealth effects, is this new monitoring capability likely to make individual workers better off, just as well off, or worse off (assuming also that new monitoring devices cannot be instituted without the mutual consent of workers and firms)? Why?

4. (20 pts.) On the next page are excerpts from a column that appeared in the Los Angeles Times a week ago Sunday. Read these excerpts and answer the following questions. Assume that stock options represent highly uncertain streams of income. Assume also no wealth effects in individuals' preferences.

a. What are the economic benefits in offering stock options to all employees? Is Elaine Franklin right when she says that doing so aligns "employee interests with those of shareholders"?

b. What are the economic costs in doing so?

c. Microsoft, unlike other software companies, pays many of its employees in part in stock options. All else equal, would you expect salaries at Microsoft to be higher, the same, or lower than at other software companies?

d. You are hired by a large manufacturing firm as a compensation consultant. Your task is to design efficient incentive contracts. Would you recommend that assembly line workers be paid in part in stock options? Why or why not? Does your answer depend on the fixed wage these workers receive?