A risk-neutral firm looks to hire a worker. The firm's output, denoted y , depends on the worker's effort e and a random factor . More precisely, y=2e+1+ , with E()=0 and Var()=2 . Suppose that the output price is equal to 1. Let the worker's utility be given by U(s,e)=E(s)Var(s)2e2 , where s denotes the salary paid by the firm. Assume the worker's utility from the best alternative job is 0. Suppose the firm offers to the worker a salary contract that takes the forms=a+by .

a) Derive the incentive compatibility and the participation constraints. [20 marks]

b) Determine the equilibrium effort level and the equilibrium salary. [20 marks]