Your company currently produces and sells software for property and casualty insurance companies.You are planning to expand the product and sell the expanded product to life insurance companies.You are currently negotiating a deal to hire Ken Lester to market this product to life insurance companies since Phil has considerable experience selling software to life insurance companies as he works for another software firm that sells to life insurance companies. Ken is paid $150,000 in his current job.The following facts are also important:

If the new product is modestly successful it will generate revenues of $500,000 and if it is very successful it will generate revenues of $800,000.The project will be modestly successful if rivals have a comparable product in the pipeline. Ken knows whether rivals have a comparable product in the pipeline or not but you don't.

The new product annual production costs are $300,000 per year plus Ken's salary. Thus the new product is profitable after paying the annual production costs and Ken's reservation salary for both revenue outcomes.

Your HR staff has come up with a proposal to pay Ken a base salary of $40,000 plus 20% of the sales that the product generates. Explain to your HR staff why offering Ken an alternative proposal, $110,000 base salary and 10% of sales revenues, is a better idea even though the incentives are a little weaker.

Hint: Risk and risk aversion are not relevant for this question. There is no risk to Ken because he knows which outcome will occur.