Assume that the manager of a key division of the Dusk Corp. has a contract, that gives her bonuses based on the profits of her division.

It is now early December. In the current year, she believes her division is likely to earn $9 million without her taking any special actions to manage earnings.

Her best forecast is that the earnings for the next year will also be about $9 million, so the two-year total is $18 million. She has the ability, by timing expenditures on things like research and training, to shift incomes somewhat.

However, there are costs to doing this, so total two-year income will be lower than the $18 million total. She could shift the incomes to be $11 million in Year 1, and $6.5 million in Year 2, or $7 million in Year 1, and $10.5 million in Year 2.

Explain what behavior would be encouraged by the contract in each case:

A. Her bonus plan gives her 2% of the profits of the division each year.

B. Her bonus plan gives her 5% of any income over $9.5 million in either year. She receives no bonus for income below this level in either year.

C. Her bonus plan gives her a bonus of $60,000 as long as Year 1 earnings are over $6 million, and a bonus in Year 2 of 2% of profits.