In the late 1990s, a large auction house, Auction Services International (ASI), employed art experts (by paying them a fixed salary package) to keep track of art from various "schools" French Impressionism, American Realism, and the like. Each expert's job was to persuade art owners to use ASI's auction services should they want to sell their art. ASI earned money by charging the art owners a percentage of the final price at auction. The art expert negotiated this rate with the art owners.

The negotiated rates were supposed to vary from 10 to 30%, depending on the art expert's assessment of the seller's willingness to pay. Instead, most of these negotiations yielded relatively low rates, much closer to 10% than 30%. Puzzled, ASI's CEO did some investigating and discovered that art experts were discounting rates in exchange for gifts from the sellerscases of fine wine, fur coats, even luxury cars. After he found out about these kickbacks, the CEO took away the experts' discretion to negotiate the rates.

The CEO's action ended the exchange of gifts for lower rates, but the experts had become accustomed to the kickbacks, considering them an important part of their compensation package. Consequently, many of the art experts quit, leaving to set up their own independent galleries in direct competition with ASI. To make matters worse, the CEO decided to set a 17% rate by conspiring with a rival auction house. When the conspiracy was discovered, the CEO was sentenced to a year in jail, and the judge tacked on a $7.5 million fine. (Total 10 marks)

A) Pinpoint all the mistakes made by the CEO of ASI for which he paid such a heavy price. (3 marks)

B) Explain the principal-agent relationship and the subsequent incentive conflict involved in this case. (4 marks)

C) If you had been appointed as a HR manager at ASI, how would you have devised the compensation package for art experts to minimize the incentive conflicts? (3 marks)