QUESTION ONE

You are deciding how to compensate and evaluate two overseas plant managers. There are two alternative compensation plans. One plan (objective compensation plan) involves giving a manager a fixed wage and bonus based on the observable revenues of the plant. The second plan (subjective bonus plan) involves giving the manager a fixed wage and a bonus based on the assessment of the plant managers effort made by a superior that periodically travels to the plant at some cost to the company to observe the managers actions and the labor market conditions.

There are two overseas plants: (1) Guam and (2) Sri Lanka. The plant revenues depend on (1) the labor market conditions in the country, and (2) the plant managers effort choice. The relationship between effort and labor market conditions for both plants are shown in following table.

Plant Revenues

	Labor Market Conditions
Effort	Cooperative	Restless	Rebellious
Superhero	$100,000	$100,000	$40,000
Hero	$100,000	$40,000	$40,000

The difference between the two plants is that the probability of the various labor market conditions. In Guam each of the three labor markets are equally likely to occur: there is a one-third chance that each of the three market conditions will occur. In Sri Lanka, there is 90% chance that the labor market conditions will be restless and a 5% chance they will be cooperative and a 5% chance they will be rebellious.

With objective performance evaluation you do not observe either plant revenue driver. Both revenue drivers are observed at a cost with subjective performance.

Your job is to describe why objective performance evaluation is relatively better for one plant (country) and why subjective performance evaluation is relatively better for the other plant given the data provided.

Note: Assume that the disutility of making superhero versus hero effort is positive. The manager needs a financial incentive to make the additional effort. But the disutility is sufficiently small that the increase in revenues as the result of making superhero efforts is larger than the incremental reservation wage in both countries.