Economics 152

Week 3 Practice Questions

Winter 2025

1.  Briefly describe three empirical studies of timing gaming.

2. Benson’s (2015) study of timing gaming showed that sales managers (who did not engage in sales themselves) were able to manipulate the sales of their subordinates to maximize their own bonuses. Describe how these sales managers accomplished this.

3. Imagine you are a car salesperson with a bonus contract that pays you $2000 in a month if you sell less than eight cars, and $3000 if you sell eight or more. If you expect to sell six this month and ten next month, discuss how you can game this system to raise your average monthly pay from $2500 to $3000. Illustrate using a diagram.  (Hint:  draw this salesperson’s reward schedule in a diagram like Figure 5.2 or 5.3 in the text, then use the same diagrammatic ‘trick’ to find expected compensation.

4. The following six statements pertain to the multi-task principal-agent problems. Please decide whether they are TRUE or FALSE, and explain your answer:

Note:  If any part of a statement is false, you should consider the entire statement as being false.

a) As long as agents are risk neutral, multi-task principal-agent problems pose no special problems for firms and workers.  The optimal contract is simply to set b=1 for every observable task the agent performs, essentially treating each task as a separate ‘mini-job’ .

b) Countrywide Financial Corporation attached strong financial incentives to maximizing  the dollar amount of mortgage lending done by its originators, with disastrous consequences for the company.

We can think of Countrywide’s problem as a multi-task principal-agent problem because its originators’ actions affected not only the total amount of lending that was done, but also its quality, --i.e. the chances the loans would be repaid.  As predicted by simple economic models, Countrywide’s originators neglected these other objectives when the quantity of output was so highly rewarded.

c) A small business’s website is useful only if (a) it is attractive and well designed, and (b) it is highly ranked in local customers’ search results.  Thus, web site design and search engine optimization (SEO) are complementary tasks to the owner of this business. (SEO makes a site more visible to search engines in a company’s target markets.)

d) Nicolle works for a small business as its general-purpose tech wizard.  She is completely indifferent as to which tech tasks she performs during a work day.  If the company attaches financial rewards to some but not all of Nicolle’s tasks, we would expect her to change her focus toward the rewarded tasks dramatically.  This is because the tasks are substitutes to Nicolle.

e) When agents perform. multiple tasks and only some of those tasks can be incentivized by the principal, some economic theorists have argued that zero financial incentives, (i.e. b=0) is the socially efficient contract.

f) In recent years, CEO pay packages have included a larger share of stock options, to incentivize CEOs to pay more attention to a company’s long term viability and profitability.

5. Multi-Task Principal Agent Problems: An Example

Suppose you are the manager of a small pizza store, and you are thinking of ways to best allocate tasks and incentivize your two employees. You have 4 tasks that you need your employees to complete each day:

Task 1:  Arriving early to open the store, so that the first customers can be served right at the advertised opening time.

Task 2: Cooking each pizza with care, so it is tasty and attractive for all customers.  Task 3: Operating the cash register so it balances to the penny at the end of the day. Task 4: Cleaning up the entire shop (including the kitchen) at the end of the day.

Since your schedule only allows you to check in on your employees at the end of the day, you can always observe whether the store has been cleaned and the cash register is balanced (Tasks 3 and 4), but you do   not observe whether Tasks 1 and 2 were performed adequately.

As the manager, you have two decisions to make:

•    Job design:  How to assign the four tasks to your two employees.  (Each employee can only do two tasks)

•    Incentivization:  Whether or not to attach significant financial rewards to adequate task

performance. Financial rewards can only be assigned to the observable tasks (tasks 3 and 4) because you can’t see how well the other two tasks were performed.

For each of the following statements, please indicate whether it is TRUE or FALSE. You should treat each question individually (i.e. any assumptions in one question do not carry over into another)

a)  Suppose you’ve decided not to incentivize any of the tasks.  Then your profits will not depend on how you assign the tasks to the employees.

b) Suppose you’ve decided to institute a high cash penalty (losing half the day’s pay) if the cash register doesn’t balance exactly or the store is dirty at the end of the day (i.e. if tasks 3 and 4 are poorly

performed).  In this case Milgrom’s theory of multi-task incentives suggests that you should assign the observable tasks (3 and 4) to one worker, and the unobservable tasks (1 and 2) to the other worker.

c) Suppose you’ve assigned tasks 3 and 4 to one worker, and tasks 1 and 2 to the other worker. In this

case, Milgrom’s theory of multi-task incentives suggests that you can attach strong financial incentives to

tasks 3 and 4.

d) Suppose you’ve assigned tasks 1 and 3 to one worker, and tasks 2 and 4 to the other worker. In this

case, Milgrom’s theory of multi-task incentives suggests that you should attach strong financial incentives to the two observable tasks (3 and 4).  That way, at least one aspect of each worker’s job is incentivized, which is better than no incentives at all.

e) Suppose that workers are indifferent between tasks 1 and 4:  Arriving early to open and staying late to clean requires the same amount of effort and time, and the workers don’t care whether they supply that effort early or late in the day. Suppose also that workers who are in the store during the day prefer to do a mix of cooking and cashiering (tasks 2 and 3), rather than doing only one of these activities (because switching makes the job more interesting).  In this case, the multi-task incentive problem will be more  severe for a worker who’s assigned to tasks 2 and 3, than for a worker who’s assigned to tasks 1 and 4.