There is a firm consisting of a manager (M) and Shareholders (S). There is one blockholder (B) and all the other shareholders are dispersed. The company has no debt. The blockholder owns a fraction of the firm. Both the manager M and the bockholder B can collect information about the available projects.

Projects:

There are three potential projects. All projects look a priori identical.

The k-th project yields the following benefits:

- k: overall net monetary payoff of k-th project to all shareholders

-bk: private benefit of k-th project to M.

If no investment is made, both S and M have a zero payoff

One of the three projects (without loss of generality let's say the third) has the following payoff.

-3 = b3 = , so that E(K) = E(bK) = . That is choosing a project without knowing which one you are choosing has a negative payout.

All agents are risk-neutral.

Alignment of interests:

The payoffs for projects 1 and 2 are as follows:

-With probability [0, 1) project 1 yields (, b) >> (0, 0) and project 2 yields (0, 0)

-With probability 1 project 1 yields (, 0) and project 2 yields (0, b)

In other words, is a congruence parameter: M and S like the same project with probability .

Information acquisition:

Both B and M exert eort to acquire information about the projects, that is, about kand bk.

E: B's eort exerted at a cost (E^2)/ 2

e: M's eort exerted at a cost (e^2)/2

M learns

-all payoffs with probability e

-nothing with probability (1 e)

B's information

-if M learns nothing then also B learns nothing

-if M learns {k, bk} for k=1,2,3 then with probability E B learns them too.

Authority:

Formal authority is always with shareholders, that is, with B as the smaller shareholders will be passive. So B has always the power to overrule M's decision.

Timeline:

1. Simultaneously B and M spend efforts (E and e respectively) to collect information.

2. B has the right to make the project choice first as she has authority over the project choice.

3. If B does not make any choice, M can pick a project (or none.)

4. Payoffs are realized.

Questions:

1. Would B or M choose a project if they were not informed about which project has which payoff. Why?

2. Write the net expected payoff for both B and M (hint: remember B only get of the total payoff for the whole shareholders' group).

3. What is the optimal amount of effort exerted by B and M?

4. How do the optimal efforts (for B and M) vary with ?