BMAN30702 CORPORATE CONTRACTING AND MANAGERIAL BEHAVIOUR 2023

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BMAN30702

CORPORATE CONTRACTING AND MANAGERIAL BEHAVIOUR

May/June 2023

SECTION B (Answer both questions )

1.Hölmstrom (1979) presents the principal-agent problem in the following way:

MaximiseE{G[x− s(x)]}                  (1)

s(x),a

Subject toE[H(s(x), a])  H                   (2)

and

a  Arg max E{H[s(x),a' ]}              (3)

a'A

where alpha (α) is the action (or effort) taken by the agent, which is picked from a set of possible actions (A). The alpha, together with the state of the world/nature (θ), determines the payoff/output to be shared between the principal and the agent (x = x(α, θ)). G is the principal’s utility function and H is the agent’s utility function. G is defined solely by wealth (w), whereas H is defined by both wealth and action. The principal observes only the output (x). In such case, the sharing rule will be a function only of the output. So s(x) is the share that goes to the agent and r(x) (where r(x) = x – s(x)) is the share of output that goes to the principal.

Using Hölmstrom’s notation, explain how one can achieve a second-best solution to this basic principal-agent problem. Also discuss possible extensions to this model; which assumptions do you have to relax to get these extensions?     (40 marks)

2.Describe and analyse the Perceived Cost Approach. Also, evaluate Kevin Murphy’s attempt to discredit the evidence supporting the Managerial Power Approach. Has he convinced you?          (40 marks)