You are considering hiring an accountant to manage your taxes. If yourtaxes are filed correctly, you will have 100,000 TL in tax claims. If they arefiled incorrectly, you will only get 25,000 TL. You know that the effort ofthe accountant will determine whether the taxes are filed correctly. If theaccountant puts in the high effort, there is an 80% chance that the taxes will befiled correctly. If he puts in a low effort, the same probability falls to 40%. Itcosts 45,000 TL to hire an accountant regardless of effort level (base wage).
a) Assume that you can observe the level of effort that the accountant puts in. What is the maximum that you would be willing to pay the accountant?
b) Now assume that you cannot observe the effort level of the accountant.
Define the incentive compatibility constraint needed to induce the accountant to put in the high effort by paying a bonus for correctly filing your taxes.
Assume that putting in the high effort has a cost to the accountant of 15,000TL.
c) Use your answer to part (b) and define a participation constraint tofind the wage contract you will need to offer to induce high effort from theaccountant. What would be the base salary level you offer and what wouldbe the bonus for a successful tax filing?
d) Finally, go back to part (a) where we assumed that you can observethe effort level of the accountant. Let us assume that there are in facttwo types of accountants: high effort and low effort and that there is anaccounting exam, which they can take to prove that they have high effort.
What should be the cost (range) of this accounting for high and loweffort accountants for it to be a credible signal?