Moral Hazard Extra Credit Problem due (via email sent to risk@garven.com) by 5 p.m. on Monday, October 16

I have written an extra credit problem set on the topic of moral hazard that will be due (via email sent to risk@garven.com) by 5 p.m. on Monday, October 16 (see http://fin4335.garven.com/fall2017/moralhazardEC.pdf). The grade received on this assignment will replace your lowest problem set grade, so long as it is higher than your lowest problem set grade.

Here are some helpful suggestions concerning how to go about working this problem set. The key learning objective for this problem set is to understand how compensation contract design affects managerial incentives to look after the interests of the firm’s owners. For simplicity, I assume here that investors are risk neutral; thus, they expect the manager to maximize the expected value of profit. Put yourself in the shoes of a compensation consultant and show the relationship between contract designs and expected profits under the various compensation scenarios that are provided in the problem set.

At your option, you may solve this problem set by hand or by creating a spreadsheet model. If you rely upon a spreadsheet model, you’ll need to include the spreadsheet as a file attachment when you send it to the risk@garven.com email address. Although a spreadsheet model is not required, you’ll find that Solver will come in very handy, particularly for answering the questions posed in parts 3-5 of the problem set.

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