QUESTION ONE.

Automobiles (car dealers) and beer (beer distributorships) are typically distributed on behalf of the manufacturer by a distributor that owns the distributorship (owns the equity in the distributorship). The car dealer buys the cars from the manufacturer and retains the profit from selling the cars at a higher price. Likewise, the beer distributor buys beer from the brewer and retains the profit from selling the beer at a higher price. The car dealer and beer distributor use their own funds to buy the equipment and buildings required to run the distributorship.

The cost to the manufacturer of distributing automobiles and beer is the discount to the retail price that the manufacturer receives from the distributor. This discount must cover the distributors capital and operating costs.

On the other hand, many fast food restaurant chain outlets are managed by an agent of the company (the manager). The outlet manager's salary is a cost for the fast food chain. The restaurant manager's incentives are set out in her contract and include end-of-year bonuses based on measures of restaurant performance.

(a)What behaviors does equity ownership provide an incentive for that contractual arrangements with outlet managers do not provide?

Hint: Don't answer this by saying that distributors with equity ownership have stronger incentives. That may be true in the particular example. However, this need not be the case. The outlet manager's bonus could be set at a very high percentage of the store profits.

(b)Why is the incentive provided with equity ownership in part (a) larger for car dealerships and beer distributorships than it is fast food restaurants?

Note: the firms in questions 2 and 3 are fictitious if their names resemble actual firms that is just because a firm name came to mind when I was developing these questions.