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1、GameTheory“Alittleknowledgeisadangerousthing.Soisalot.”-AlbertEinsteinTopic7 InformationStrategicUseofInformationIncentiveSchemesCreatingsituationsinwhichobservableoutcomesrevealtheunobservableactionsoftheopponents.ScreeningCreatingsituationsinwhichtheb
2、etter-informedopponents’observableactionsrevealtheirunobservabletraits.MikeShor2MoralHazard&RouletteMikeShor3$50MoralHazardAprojectwithuncertainoutcomeProbabilityofsuccessdependsonfirm’seffortprob.ofsuccess=0.6ifeffortisroutineprob.ofsuccess=0.8ifeffort
3、ishighFirmhascostofeffortcostofroutineeffort=$100,000costofhigheffort=$150,000projectoutcome=$600,000ifsuccessfulMikeShor4CompensationSchemesBenchmarks:FixedPaymentObservableEffortResult-contingentbonusschemeMikeShor5IncentiveScheme1:FixedPaymentAfixedp
4、aymentmustbehighenoughtogetthefirmtoaccepttheprojectNoamountoffixedpaymentcanchangethefirm’sbehavioronceitacceptstheprojectMikeShor6IncentiveScheme1:FixedPaymentForanyfixedpayment,effortwillbelow:Payment-$100,000>Payment-$150,000OptimalPaymentLowestposs
5、ibleFirmrequiresatleast$100,000Payment=$100,000ExpectedProfitValueofproject—payment=(.6)$600K—$100K=$360-$100=$260KMikeShor7IncentiveScheme2:ObservableEffortIfwecanobserveeffort,contractsaresimple:Workashardaswetellyouto,oryouarefiredOnlyquestion:Howhar
6、ddowewantemployeestowork?Remember,salarymustbecommensuratewithlevelofeffort,ornoonewilltakethejobMikeShor8IncentiveScheme2:ObservableEffortFirmputsintheeffortlevelpromised,givenitspayPayforroutineeffort:Avg.Profit=(.6)600,000–100,000=$260,000Payaddition
7、al$50Kforhigheffort:Avg.Profit=(.8)600,000–150,000=$330,000Ifeffortisobservable,payforhigheffortExpectedProfit=$330KMikeShor9ProblemsFixedpaymentschemeoffersnoincentivesforhigheffortHigheffortismoreprofitableWorstcasescenario:$260KEffort-basedschemecann
8、otbeimplementedCannotmonitorfirmeffortBestcasescenario:$330KQuestion:howclosecanwegettobestcasescenarioifeffortisunobservable?MikeShor10IncentiveScheme3:FixedPaymentandBonusSupposeeffortcannotbeobservedIncentive-Compatiblecompens
