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2) An entrepreneur has an idea for a new project that if successful it could be worth $100K. However, if unsuccessful the project is
2) An entrepreneur has an idea for a new project that if successful it could be worth $100K. However, if unsuccessful the project is worthless. He needs manager to supervise the project. If the manager puts in high effort there is a 60% chance of success, otherwise there is only a 30% chance of success. Managers on average earn $30K in the amount of time it will take to complete the project. High effort costs managers the equivalent of $6000 in utility and they are risk neutral. a) Assume effort is observable. What contract should the entrepreneur offer if he only wants low effort? What are his expected profits from such a contract? b) What contract should the entrepreneur offer if he only wants high effort? What are his expected profits from such a contract? c) If effort is observable, which contract should the manager offer? What problem arises as soon as effort is unobservable? d) Suppose the entrepreneur wants to write an incentive contract to induce high effort such that the manager receives x if the project is successful and y if not. What are the participation and incentive-compatibility constraints? e) What is the optimal incentive contract such that the manager receives .x if the project is successful and y if not? What are the entrepreneur's expected profits from such a contract? What are the manager's expected profits
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