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 behvior.  In Jensen's piece on takeovers, he asserts that high debt levels can serve to improve managers incentives. 

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 not effort. 

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 in traffic. 

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 face. 

4.. 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.