Jerry runs a small carpet store. His firm sells and installs carpets. He manages the operation from his office in the store where carpet is displayed. He pays his receptionist/secretary an hourly wage.

In general, what is the advantage of paying an hourly wage? What incentive problem might this create? How might Jerry be able to manage this problem?

He has a saleswoman in the office whose job is to sell carpet to people who come in shopping; she sells carpet that Jerry has already priced by the yard. Jerry pays this woman on a commission basis, as a fraction of the revenue generated.

In general, what is the advantage of paying a commission? In general, what incentive problem does paying a commission based on revenue generation create? How does Jerry attempt to control for this issue?

Jerry also employs a salesman who goes to people's homes to price the installation of carpet. This man has discretionary authority to price the carpet, including installation, as needed since each job has unique aspects to it, and Jerry has a profit-sharing arrangement with him: he gets to keep half of the profit he generates over and above the cost of the carpet plus installation.

In general, what is the advantage of a compensation plan based on profit sharing? Are there incentive problems with this arrangement? What should Jerry be concerned about with this plan?

Finally, Jerry employs a couple of guys who actually install carpet in homes. Jerry pays them by the job, so many dollars per square yard installed, with a penalty in the event that any customer complains after the job is done.

In general, what is the advantage of paying "by the job"? What incentive problem might this create? Is Jerry able to control for this problem effectively with the penalty?

Finally, with reference to any principal-agent (i.e., moral hazard) problems, critique the way Jerry compensates his employees. Then give Jerry a grade on his compensation policies (e.g., A+, B-, D, etc.).

Your critique/assessment:

Your letter grade for Jerry's compensation plan: