Part 1 (30%) -How to Pay Mark?

Consider this situation.Julie is the owner of an airport shuttle. The shuttle transports passengers between Bowling Green and the Nashville Airport. Most customers pay with cash because there is a big discount.Since she is old and spends most of the time in Florida, she hired Mark, as the only employee and driver. Julie is far away from Bowling Green, therefore she has to believe Mark unless there is an unambiguously clear evidence against Mark's claim/report. Assume that Mark is rational (in economics,rationalis synonymous withselfish) and he willalwayscheat on Julie if doing so is beneficial (increasing his monetary benefits).

Julie is considering the following five possible compensation methods:

I)Pay Mark a flat salary (e.g., $3,500 each month)

II)Pay Mark an amount equal to reported revenue less fixed amount

(e.g., reported revenue less $3,000; negative pay if reported revenue < $3,000)

III)Pay Mark a certain percent of sales (e.g., 30% of reported fares from passengers)

IV)Pay Mark on an hourly basis (e.g., $25 per hour * Reported work hours)

V)Pay Mark based on the mileage (e.g., $0.30 for each mile added in the mileage gauge)

VI)Pay Mark based on his efforts (how hard he works)

Julie is trying to find the best methodin avoiding potential cheating by Mark.

Required:

A. Which of the following methods is the best one as far as the owner Julie is concerned? Andwhy?

B. For each of the other 5 methods (the ones you did not choose in A), explain why it is not good for Julie.

Part 2 (40%) New Soviet Incentive Scheme - Information Elicitation Model

[When you work for a company after you graduate, if you present the idea to your boss/company, you will be commended /compensated / promoted]

This idea was used by now defunct socialist country of Soviet Union (now Russia) and it became a good subject of managerial accounting.

Tom is a salesman in the defense industry. He sells very expensive high-tech equipment. The defense industry market is very complex. Therefore, questions like "how many units of sales are considered as a success?" are very hard to answer for people other than salespeople in this area. As an experienced salesman, Tom knows the market very well. His boss, who had a financial job until a year ago, knows little about it.

Tom is evaluated based on actual sales compared to the goal.The company has allowed Tom to have upper hand and let him set the goal. Tom thinks he can sell 100 units. But he wants to appear hard-working. So he tells the boss that he can sell 90 units, and 90 becomes the goal. Then, he will actually sell 100 units, and the boss will be impressed, thinking that Tom really worked hard and over-achieved the goal.

The company has hired Gorky, a compensation/management specialist. He proposed the following compensation scheme.

Tom's Compensation=j G + k (A - G),if A G (achieving or exceeding goal)

=j G - m (G - A), if A < G (under-achieving goal)

where, A = Actual sales units by Tom, G = Goal (in sales units) set by Tom

Gorky said that under this scheme, thetwo conditionsbelow are satisfied.

(i)Tom will never lie when setting the goal.(For example, if Tom knows he can sell 100, he will set the goal at 100. He will not set the goal at 90 and actually achieve 100). He will honestly set the goal. The goal reveals his private knowledge. Why does he honestly set the goal? Because by doing so, Tom will get the better compensation.

(ii)After setting the goal, things could change. Whatever goal Tom set, it was in the past (sunkif we use the term studied in Ch. 3).So,after the goal is set, Tom will try hard to sell as many as possible, regardless of the goal.(For example, let's say the goal was 100, he will get more pay if he sell 110 rather than 100; selling 120 is better than 110;selling 90 is better than 80, etc.)

For the compensation scheme to work in the way as Gorky described, we need to correctly determine the values ofj,k, andmin the above model.

Required:

A. FindANY set of values ofj,k, andm.Make sure that the set of numbers ALWAYS satisfies Conditions (i) and (ii) above.

B. Explainwhy (economic reasons) the numbers are chosen the way you choose.

Hints

j, k, m are all between 0 and 1.

j, k, m are different from each other.

There are an infinite number of possible sets of values.

You just need to find only one set of values.

For you to check answers, we have a pre-structured Excel worksheet (310-C3-Part2) is provided in this case assignment.Definitely, you want to use it.

If you included the completed worksheet, you could get partial credit (even though your answer is incorrect).

Part 3 (10%) - Unambiguous Performance Evaluation

Susan is a photographer for a travel magazine. She went toHawaiito take photos. The photos were blurry and the magazine editorquestions Susan's ability as a professional photographer. Susan claims that the weather was bad, and it was not her fault. In what ways can we evaluate her ability as a photographer?

Part 4 (20%) -Angry with the Company!

Mr. Smith had recently flown into Chicago on a commercial airline for a two-day business trip. While there, he learned that his company's private airplane had flown in the day before and would leave on the same day that he was scheduled to leave. Mr. Smith immediately cashed in his $400 commercial airline ticket and flew back on the company's jet. He flew home feeling pretty good about saving his company the $400 fare.

Two weeks later, however, his boss asked him why the department had been cross-charged $625 for his return trip.The $625 amount is based on the company's estimation on the total jet operating costs of $6,250,000 and the total trips of 10,000.Mr. Smith explained that "the company's jet was flying back regardless, and there were empty seats."Mr. Smith's attempt to save his company $400 ended up "costing" his department $625.

Now, Mr. Smith is at JFK airport in New York. His company's jet is sitting on the runway with a number of empty seats and ready to take off for the very same destination. Yet there was no way Mr. Smith is going to fly on that jet.

Required:

Addthe reasonswhyin answering each question below.

A. Why is that the company charges for the use of jet, even though it is used for company's business?

What if it does not charge?

B. What is the problem here?

C. Was Mr. Smith's action the "best" decision for his department?

D. Was Mr. Smith's action the "best" decision for for the company?

E. If there are many disgruntled employees like Mr. Smith, what will happen to the demand for the jet use?

F. What will happen to the charge of using it?