Economics 174

Problem Set 2 -- Due Monday, October 21

1. Why would entrepreneurs voluntarily enter into agreements which limit their discretion on matters such as which types of new products to develop?

2. Some economic studies use the fact that stock prices rise after hostile takeovers as evidence that takeovers are efficiency-enhancing. Do Shleifer and Vishny believe that one can always use stock prices as evidence in this way? If so, what is their reasoning? If not, describe a circumstance where a hostile takeover might be efficiency-decreasing but where the stock price would increase.

3. Read the following two Wall Street Journal articles about Ben and Jerry's Homemade, Inc. and answer the following questions.

Company Background. News Story.

a) How are the stated objectives of Ben and Jerry's different than most firms'?

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 public? Explain.

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.

4. Suppose a risk-neutral firm pays each of its workers a function of the output they produce rather than a fixed wage. Suppose workers' output is separable, but is affected by circumstances outside of their control (such as the weather) as well as their effort.

Assuming that each of the workers is risk-neutral, is this compensation scheme likely to be efficient? Why or why not?