Consider the following example. A risk-neutral worker can choose high or low effort. The worker's outside option is 0. The manager cannot observe the worker's action, but the manager can observe the realized revenue for the firm (either $100 or $200). The probability of each revenue depends on the worker's effort:
Low effort: cost of effort : $0 probability of low revenue ($100) : 75% probability of high revenue ($200) : 25%
High effort: cost of effort : $11 probability of low revenue ($100) : 25% probability of high revenue ($200) : 75%
The manager offers a contract which gives the worker a flat wage of $10 and a bonus of $20 if revenue is high. Given this payment scheme, the worker will put in___effort. The contract (is/is not)incentive compatible. The firm's expected profit is $.
The firm is considering an investment that would increase worker morale. By making work more enjoyable, the program would reduce the worker's cost of effort from $11 to $9. If it costs the firm $20 to implement this program, the firm's expected profit if they implement the program is $. The firm implement the program.