Incentive Theory

Exercise 3 A principal (she) employs an agent (he) for one period to produce output Q = Ve + u, where e is the agent's work effort and u is a random term that captures all factors beyond the agent's control. Both variables e and u are not verifiable, but it is common knowledge that u ~ N(0,1). The value of output to the principal is given by V(Q) = 20. When working, the agent incurs effort costs given by c(e) = 5e, and he re- ceives a wage w + pQ. Assume that agent's utility function is given by u(v) = 1 exp(-rv), where o