Baye 9e - Chapter 06 - TB

Chapter 06 - The Organization of the Firm
Chapter 06
The Organization of the Firm
Multiple Choice Questions
1. Often owners of firms who hire managers must install incentive or bonus plans to ensure
that the:
A. company is financially secure.
B. manager will work hard.
C. manager will maintain employee morale.
D. company will have positive economic profits.
Answer: B
Learning Objective: 06-04
Topic: Managerial Compensation and the Principal–Agent Problem
Blooms: Understand
AACSB: Knowledge Application
Difficulty: 02 Medium
2. Which of the following forms of payment is NOT an incentive plan?

A. Commission plans for salesmen
B. Flat salary for a plant manager
C. Bonuses for managers that increase as profits increase
D. None of the statements is correct.
Answer: B
Blooms: Understand
3. Which of the following is NOT an incentive scheme to ensure that workers do a good job?
A. Paying waitresses low wages, but allowing them to collect tips
B. Profit-sharing plans in large companies
C. Commission pay schedules for salesmen
D. Straight hourly wages for dock workers
Answer: D
Topic: The Manager-Worker Principal–Agent Problem
Blooms: Understand
6-1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
4. Which of the following is NOT a means of avoiding opportunism?

A. Contracts
B. Spot exchange
C. Vertical integration
D. Long-term contracts
Answer: B
Topic: Optimal Input Procurement
Blooms: Understand
5. Long-term contracts become longer:

A. when specialized investment becomes more important.
B. when the exchange environment is more complex.
C. when spot markets work well.
D. when marginal costs are declining.
Answer: A
Blooms: Analyze
AACSB: Analytical Thinking
Difficulty: 03 Hard
6. A relationship-specific exchange occurs when:

A. a partnership is dissolved.
B. specialized investments are important.
C. a partnership is initiated.
D. shareholders receive dividends.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
7. When relationship-specific exchange occurs in complex contractual environments, the best

way to purchase inputs is through:
A. spot markets.
B. vertical integration.
C. short-term agency agreements.
D. long-term contracts.
Answer: B
6-2

Blooms: Remember
Difficulty: 01 Easy
8. A firm might choose to produce its own inputs if:

A. specialized investment is not important.
B. long-term contracts are costly to write.
C. the exchange environment is not complex.
D. spot markets for the input exist.
Answer: B
Blooms: Understand
9. An agent hired by the owner of productive resources to control the production process is:
A. a laborer.
B. a self-proprietor.
C. an assembly worker.
D. a firm manager.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
10. Spot exchange can be inefficient in the presence of:

A. opportunism.
B. a complex contracting environment.
C. spot checks.
Answer: A
Topic: Methods of Procuring Inputs
Blooms: Understand
6-3
11. A negative side of long-term contracts is:

A. high transaction costs.
B. a loss of flexibility.
C. the continual need to renegotiate the contract.
Answer: B
Blooms: Understand
12. Spot markets are an efficient way for the firm to purchase inputs if:
A. opportunism is not a problem.
B. suppliers engage in hold-up.
C. profit sharing is used to compensate managers.
D. the supplier needs specialized investment to produce the input.
Answer: A
Blooms:Remember
Difficulty: 01 Easy
13. The disadvantage of vertical integration is that:

A. relationship-specific exchange may cause hold-up.
B. long-term contracts may be inflexible.
C. the principal–agent problem causes shirking.
D. firms no longer specialize in what they do best.
Answer: D
Blooms: Understand
14. In the absence of worker incentives:

A. everyone always gives maximum effort.
B. there is a natural tendency for workers to not give their maximum effort.
C. managers have little or no control.
Answer: B
Blooms: Remember
6-4

Difficulty: 01 Easy
15. A person who monitors the production process and evaluates the productivity of workers
is:
A. a manager.
B. an employee.
C. a shareholder.
D. a self-proprietor.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
16. A drawback of separating ownership from control by creating a firm is:

A. the losses of specialization.
B. increased transaction costs.
C. the principal–agent problem.
D. synergies of team production.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
17. Shirking can take the form of:

A. long lunch hours.
B. sleeping at work.
C. leaving work early.
D. All of the statements associated with this question are correct.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
6-5
18. Which of the following payment plans does NOT give an incentive to a manager to stop
shirking?
A. Flat salary with additional pay based on profits of the firm
B. Pay schedule based solely on profits earned by the firm
C. Flat salary regardless of firm profits
D. None of the preceding statements is correct.
Answer: C
Topic: Forces that Discipline Managers
Blooms: Understand
19. The most likely effect of reducing performance-based rewards for the CEOs of
corporations would be:
A. an increase in profits.
B. a drop in revenues.
C. a drop in profits.
D. an increase in the value of the corporation.
Answer: C
Blooms: Understand
20. Suppose compensation is given by W = 512,000 + 217π + 10.08S, where W = total

compensation of the CEO, π = company profits (in millions) = $200, and S = sales (in
millions) = $400. How much will this CEO be compensated?
A. $812,431
B. $43,400
C. $559,432
D. $512,000
Answer: C
Blooms: Apply
Difficulty: 01 Easy
6-6
21. Suppose compensation is given by W = 512,000 + 217π + 10.08S, where W = total

compensation of the CEO, π = company profits (in millions) = $200, and S = sales (in
millions) = $400. What percentage of the CEO's total earnings are tied to profits of the firm?
A. 8.2 percent
B. 10.9 percent
C. 7.8 percent
D. 5.1 percent
Answer: C
Blooms: Apply
22. An incentive for managers to maximize profits is:

A. reputation.
B. performance bonuses.
C. takeovers.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
23. A manager who tries to enhance worker effort by tying workers' compensation to the
profitability of the firm is using:
A. spot checks.
B. revenue sharing.
C. profit sharing.
D. piece rates.
Answer: C
Blooms: Understand
6-7
24. A payment plan that induces better worker effort by linking compensation to revenues of
the firm is known as:
A. revenue sharing.
B. profit sharing.
C. piece rate sharing.
D. spot checking.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
25. An example of a job that usually involves a revenue-sharing plan would be:
A. waiters and waitresses.
B. car salesman.
C. insurance agents.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
26. A negative side of a revenue-sharing plan is that it:

A. does not induce hard or better work.
B. can be costly if revenues are low.
C. gives no incentive for workers to minimize costs.
D. can be difficult to manage from an accounting standpoint.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
27. Which of the following is NOT an example of a piece-rate compensation method?

A. Paying typists a fixed amount per page
B. Paying sewing machine operators a flat amount per shirt sewn
C. Paying a carpenter to install a new back porch
D. Paying an assembly line worker per bolt put into car bodies
Answer: C
6-8

Blooms: Understand
28. A potential problem with piece-rate plans is that:

A. workers will produce a large quantity.
B. workers have no incentive to work hard.
C. it is difficult for managers to control.
D. workers may stress quantity instead of quality.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
29. When a manager enters the workplace from time to time to monitor workers, he is using:
A. a profit-sharing plan.
B. spot checks.
C. a revenue-sharing plan.
D. a piece-rate payment plan.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
30. In order for spot checks to be effective, they must be:

A. random in nature.
B. performed at regular intervals.
C. partaken twice daily.
D. rarely if ever done.
Answer: A
Blooms: Understand
6-9
31. Which type of compensation mechanism works by threats?

A. Piece rate
B. Spot check
C. Revenue sharing
D. Profit sharing
Answer: B
Blooms: Remember
Difficulty: 01 Easy
32. Which type of compensation method works by performance bonus?

A. Profit sharing
B. Revenue sharing
C. Piece rate
Answer: D
Blooms: Remember
Difficulty: 01 Easy
33. The most commonly used negative incentive used by firms is:
A. temporary layoffs.
B. dismissal.
C. unpaid suspensions.
D. verbal reprimands.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
34. The LEAST risky payment plan from the viewpoint of the worker is:
A. piece rate.
B. profit sharing.
C. revenue sharing.
D. hourly wage.
Answer: D
Blooms: Remember
6-10

Difficulty: 01 Easy
35. To ensure quality, piece-rate plans must usually be accompanied by:

A. quality control mechanisms.
B. time clocks.
C. spot checks.
D. profit-sharing plans.
Answer: A
Blooms: Understand
36. Transaction costs refer to:

A. fixed costs of capital.
B. variable costs of labor.
C. costs of exchange unrelated to production costs.
D. economies of scale.
Answer: C
Topic: Transaction Costs
Blooms: Understand
37. Spot checks:

A. measure presence only.
B. monitor the effort of workers precisely.
C. are the same as spot markets.
D. must be frequent enough to induce workers not to risk getting caught shirking.
Answer: D
Blooms: Understand
6-11
38. Spot checks work because of:

A. the promise of a reward.
B. a promise of performance-based pay.
C. a potential penalty for shirking.
D. monitoring on a regular basis.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
39. An increase in the likelihood of a dismissal:

A. raises productivity at an increasing rate.
B. raises productivity at a decreasing rate.
C. decreases productivity at a decreasing rate.
D. decreases productivity at an increasing rate.
Answer: B
Blooms: Understand
40. High transaction costs:

A. occur when specialized investment is not important.
B. make spot exchange an efficient way to obtain inputs.
C. may be a result of buyer opportunism.
D. may be the result of downward-sloping demand.
Answer: C
Blooms: Understand
41. Long-term contracts are NOT efficient if:

A. a firm engages in relationship-specific exchange.
B. specialized investments are unimportant.
C. the contractual environment is simple.
D. managers shirk.
Answer: B
Blooms: Understand
6-12

42. Which of the following occurs as firm size grows?

A. A decrease in the number of managers needed.
B. A decrease in transaction costs.
C. A loss of opportunity cost.
D. Administrative and bureaucratic costs rise at an increasing rate.
Answer: D
Blooms: Understand
43. If a manager wishes to produce a large level of output, which compensation mechanism is
most effective?
A. Spot check
B. Piece rate
C. Revenue sharing
D. Profit sharing
Answer: C
Blooms: Understand
44. Which of the following mergers is an example of vertical integration?

A. Bethlehem Steel purchases U.S. Steel.
B. IBM purchases a California computer chip company.
C. AT&T purchases MCI.
D. GM purchases Ford.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
6-13
45. If a firm manager has a base salary of $50,000 and also gets 2 percent of all profits, how
much will his/her income be if revenues are $8,000,000 and profits are $2,000,000?
A. $250,000
B. $210,000
C. $90,000
D. $150,000
Answer: C
Blooms: Apply
46. If a firm manager has a base salary of $100,000 and also receives 5 percent of all profits,
what percentage of his/her final income will be from a profit-sharing plan when profit equals
$1,500,000?
A. 51 percent
B. 27 percent
C. 43 percent
D. 48 percent
Answer: C
Blooms: Apply
47. The principal's goals are NOT in line with the goals of:
A. any other principal.
B. the agents.
C. the firms.
D. the consumers.
Answer: B
Blooms: Understand
6-14
48. The agent is an individual:

A. who acts independently of the principal.
B. who can direct the principal to achieve goals.
C. hired by the principal to achieve goals.
D. hired by the principal to consult with him.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
49. The principal–agent problem refers to the fact that the agent's goals:
A. do not always coincide with those of the principal.
B. coincide with those of the principal.
C. do not overlap with those of the principal.
D. overlap with those of the principal.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
50. Principal–agent problems do NOT arise between:

A. stockholders and managers.
B. managers and workers.
C. stockholders and workers.
D. workers and consumers.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
51. Solving the principal–agent problem ensures that the firm is operating:
A. on the production function.
B. above the production function.
C. below the production function.
D. above the isoquant curve.
Answer: A
Blooms: Understand
6-15

52. Which of the following methods might be an efficient way of obtaining inputs when
specialized investments are not important?
A. Spot exchange
B. Vertical integration
C. Profit-sharing
D. Long-term contracts
Answer: A
Blooms: Understand
53. Specialized investments:

A. result in relationship-specific exchange.
B. make spot exchange efficient.
C. cause managers to shirk.
D. are equally valuable in any productive use.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
54. Vertical integration:

A. occurs when a firm purchases its inputs in a market.
B. is attractive when relationship-specific exchange is unimportant.
C. occurs when a firm produces its own inputs.
D. is a spot exchange phenomenon.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
55. If a manager is not the owner, the manager:

A. receives the full benefit of good decisions.
B. bears the full cost of bad decisions.
C. does not receive the full benefit nor the full cost of his or her decisions.
6-16
Answer: C
Blooms: Understand
Difficulty: 01 Easy
56. When the owner runs the business:

A. he does not bear the full cost of a bad decision.
B. there is not a principal–agent problem.
C. he does not receive the full benefit nor the full cost of any decision.
D. he has only limited liability for the actions of the business.
Answer: B
Blooms: Understand
Difficulty: 01 Easy
57. A long-term contract:

A. occurs when a firm produces its own inputs.
B. is most likely in complex exchange environments.
C. exists when a firm is legally bound to purchase inputs from a particular supplier.
D. is shorter when specialized investments are important.
Answer: C
Blooms: Remember
Difficulty: 03 Hard
58. A spot exchange involves a market where goods are bought and sold at a:
A. contracted market price.
B. prevailing market price.
C. predetermined market price.
D. post-determined market price.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
6-17
59. A firm chooses the institution to purchase inputs:

A. which minimizes the transactions costs of obtaining inputs.
B. in order to create more divisions.
C. which minimizes worker shirking.
D. to implement profit sharing.
Answer: A
Blooms: Understand
60. Hold-up:
A. is a hazard associated with relationship-specific exchange.
B. mitigates worker shirking.
C. makes spot exchange efficient.
D. solves the principal–agent problem.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
61. A firm manager is an agent hired by the:

A. owner to control the production process.
B. workers to control the production process.
C. workers to consult with the owner.
D. owner to oversee the workers.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
62. The principal–agent problem happens because the owner cannot:

A. control the production process.
B. spend time at the physical plant site.
C. monitor the efforts of the manager.
D. evaluate the efforts of the manager.
Answer: C
Blooms: Remember
6-18

Difficulty: 01 Easy
63. Spot exchange typically involves:

A. no transaction costs.
B. some transaction costs.
C. extremely high transaction costs.
D. long-term contracts.
Answer: B
Blooms: Understand
64. Long-term contracts:

A. increase transaction costs and increase opportunism.
B. increase transaction costs.
C. can reduce opportunistic behavior.
D. reduce transaction costs and increase flexibility.
Answer: C
Blooms: Understand
65. The problem with spot exchange in the presence of specific assets is that both parties:
A. have incentives to behave as principals.
B. have incentives to behave opportunistically.
C. take the risk of price fluctuations.
D. do not take advantage of the economies of scope.
Answer: B
Blooms: Understand
6-19
66. Relationship-specific investments include:

A. site specificity.
B. dedicated assets.
C. human capital.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
67. One way of alleviating opportunism is:

A. spot exchange.
B. dedicated assets.
C. vertical integration.
D. contracts in complex contracting environments.
Answer: C
Blooms: Understand
68. The specificity of the asset (or investment) leads to the possibility of:
A. collusion.
B. prisoner's dilemma.
C. opportunism.
Answer: C
Blooms: Understand
69. Which of the following institutions may result in hold-up?

A. Vertical integration
B. Piece rates
C. Long-term contracts
D. Spot markets
Answer: D
Blooms: Understand
6-20

70. Relationship-specific exchange:

A. is a consequence of profit sharing.
B. makes firms use spot markets.
C. occurs because of specialized investments.
D. reduces worker shirking.
Answer: C
Blooms: Remember
Difficulty: 01 Easy
71. Long-term contracts are LESS likely when:

A. specialized investments are important.
B. hold-up is likely.
C. the exchange environment is complex.
D. workers are paid based on piece rates.
Answer: C
Blooms: Understand
72. Under a profit-sharing compensation scheme, the manager will:

A. shirk all day.
B. not shirk all day.
C. optimize his choice between income and leisure.
D. do the same thing as under a fixed salary scheme.
Answer: C
Blooms: Understand
Difficulty: 01 Easy
6-21
73. By making managerial compensation depend on the performance of the firm's profits, the
firm owner's profits:
A. rise.
B. fall.
C. remain constant.
D. initially fall, then rise.
Answer: A
Blooms: Understand
74. Given that the income of franchise restaurant managers is directly tied to profits and the
income of the manager of the company-owned restaurant is paid a flat fee, we might expect
profits to be:
A. higher in company-owned restaurants.
B. lower in company-owned restaurants.
C. equal in both types of restaurants.
D. None of the statements are correct.
Answer: B
Blooms: Understand
75. Franchising mitigates:

A. opportunism.
B. relationship-specific investment.
C. the hold-up problem.
D. the principal–agent problem.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
6-22
76. It would be undesirable to reduce the executive's compensation if her earnings are due
largely to:
A. a flat fee.
B. performance.
C. the owner's demand.
D. the employee's demand.
Answer: B
Blooms: Understand
77. If we reduce performance-based rewards to CEOs, the profits of firms will:

A. rise.
B. fall.
C. remain constant.
D. None of the answers are correct.
Answer: B
Blooms: Understand
78. Which of the following is an outside incentive that forces managers to put forth maximal
effort?
A. Incentive contracts
B. Performance bonuses
C. Flat fees
D. Reputation
Answer: D
Blooms: Remember
Difficulty: 01 Easy
79. The cost to a manager of doing a poor job running the firm is:
A. a decrease in his fixed salary.
B. a decrease in the profit of the firm.
C. a decrease in the sales of the firm.
D. an increase in the likelihood of being replaced.
Answer: D
6-23

Blooms: Remember
Difficulty: 01 Easy
80. Which of the following is NOT a solution to the manager-worker principal–agent

problem?
A. Sales sharing
B. Piece rates
C. Fixed hourly wages
D. Spot checks
Answer: C
Blooms: Remember
Difficulty: 01 Easy
81. A profit-sharing pay scheme:

A. increases both productivity and profits.
B. decreases productivity but increases profits.
C. increases productivity but decreases profits.
D. decreases both productivity and profits.
Answer: A
Blooms: Remember
Difficulty: 1 Easy
82. One problem with revenue-based incentive schemes is they do NOT provide an incentive
to:
A. maximize profit.
B. maximize sales.
C. minimize costs.
D. maximize productivity.
Answer: C
Blooms: Understand
6-24
83. A potential problem with paying workers based on a piece rate is that:
A. effort cannot be expended engaging in quality control.
B. effort should not be expended engaging in quality control.
C. workers will attempt to produce quality at the expense of quantity.
D. workers will attempt to produce quantity at the expense of quality.
Answer: D
Blooms: Understand
84. Which of the following is NOT a benefit associated with producing inputs within a firm?
A. Reduction in transaction costs.
B. Gains of specializing.
C. Reductions in opportunism.
D. Mitigation of hold-up problem.
Answer: B
Blooms: Understand
Difficulty: 03 Hard
85. In order for spot checks to work:

A. employees must be monitored continually.
B. the time of the checks must not be predictable.
C. Both A and B are correct.
Answer: B
Blooms: Understand
Difficulty: 01 Easy
86. Which of the following involves the most risk from the point of view of the employee?
A. Piece rate
B. Profit sharing
C. Hourly wage
D. Annual salary
Answer: B
Blooms: Understand
6-25

Difficulty: 01 Easy
87. Long-term contracts are generally preferable to:

A. spot markets.
B. short-term contracts.
Answer: D
Blooms: Understand
88. Which of the following is the primary disadvantage of producing inputs within a firm?
A. Increases in transaction costs
B. Loss of specialization
C. Reductions in opportunism
D. Mitigation of hold-up problems
Answer: B
Blooms: Understand
Difficulty: 03 Hard
89. Which of the following involves the LEAST risk from the point of view of the employee?
A. Piece rate
B. Profit sharing
C. Revenue sharing
D. Annual salary
Answer: D
Blooms: Understand
Difficulty: 01 Easy
6-26
90. Spot markets are generally preferable to:

A. long-term contracts.
B. short-term contracts.
Answer: D
Blooms:Understand
91. Which of the following forms of payment is NOT an incentive plan?

A. Commission plans for salespeople
B. Paying waitresses low wages, but allowing them to collect tips
C. Bonuses for managers that increase with profits
D. Straight hourly wages for construction workers
Answer: D
Blooms: Understand
Difficulty: 01 Easy
92. A positive side of long-term contracts is:

A. low transaction costs.
B. a loss of flexibility.
C. the continual need to renegotiate the contract.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
93. Spot markets are an INEFFICIENT way for the firm to purchase inputs if:
A. opportunism is a problem.
B. suppliers engage in hold-up.
C. profit sharing is used to compensate managers.
D. opportunism is a problem and suppliers engage in hold-up.
Answer: D
Blooms: Understand
6-27

Difficulty: 01 Easy
94. The activity known as shirking is LEAST likely to occur when:

A. workers are not monitored.
B. the earnings of a worker are closely tied to the worker's output.
C. all workers are paid the same wage rate.
D. firm ownership is separated from the managerial control.
Answer: B
Blooms: Understand
Difficulty: 01 Easy
95. Suppose compensation is given by W = 450,000 + 220  + 15S, where W = total

compensation of the CEO,  = company profits (in millions) = $300, and S = sales (in
millions) = $500. What percentage of the CEO's total earnings is tied to profits of the firm?
A. 6.0 percent
B. 7.9 percent
C. 12.6 percent
D. 43.4 percent
Answer: C
Blooms: Apply
96. Revenue sharing tries to induce worker effort by linking:

A. worker compensation to profits.
B. worker compensation to revenues.
C. worker output to profits.
D. worker output to revenues.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
6-28
97. A potential problem with piece-rate plans is that:

A. workers will have a tendency to under-produce the good.
B. workers have no incentive to work hard.
C. workers may put little emphasis on the quality of the good.
D. it is difficult for managers to enforce.
Answer: C
Blooms: Understand
98. Which type of compensation method does NOT involve a performance bonus?
A. Profit sharing
B. Revenue sharing
C. Piece rate
Answer: D
Blooms: Remember
Difficulty: 01 Easy
99. Which of the following is NOT a transaction cost associated with using inputs?
A. Time spent negotiating labor contracts with union workers
B. Opportunity costs of negotiating the price of renting machines
C. Wages paid to labor
D. Costs of searching for a new supplier of machines
Answer: C
Blooms: Understand
Difficulty: 01 Easy
100. As firms increase in size, they tend to experience a:

A. decrease in the need for managers.
B. decrease in transaction costs.
C. loss of opportunity cost.
Answer: D
Blooms: Understand
6-29

101. Suppose a firm manager has a base salary of $75,000 and earns 1.5 percent of all profits.
Determine the manager's income, if revenues are $10,000,000 and profits are $5,000,000.
A. $75,000
B. $150,000
C. $225,000
D. $300,000
Answer: B
Blooms: Apply
102. Given that the income for a franchise restaurant manager is directly tied to profits, while
the income for the manager of a company-owned restaurant is paid a flat fee, we might expect
profits to be:
A. lower in franchise restaurants.
B. higher in franchise restaurants.
C. equal in both types of restaurants.
D. Profit comparisons cannot be made based on the given information.
Answer: B
Blooms: Understand
103. Generally, revenue-based incentive schemes:

A. reduce incentives to produce low-quality products.
B. increase incentives to minimize costs.
C. reduce worker productivity.
D. reduce incentives to produce low-quality products and increase incentives to minimize
costs.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
6-30
104. Which of the following is an outside incentive that forces managers to put forth maximal
effort?
A. Revenue-sharing contracts
B. Performance bonuses
C. Threat of takeovers
D. Flat fees
Answer: C
Blooms: Remember
Difficulty: 01 Easy
105. Point A in the figure below is:
A. efficient since it produces 20 units of output at the lowest possible cost.

B. efficient since it produces 10 units of output at the lowest possible cost.
C. inefficient since it produces 20 units of output at a cost greater than the minimum cost.
D. inefficient since it produces 10 units of output at a cost greater than the minimum cost.
Answer: C
Blooms: Analyze
6-31
106. Point B in the figure below is:
A. efficient since it produces 20 units of output at the lowest possible cost.

B. efficient since it produces 10 units of output at the lowest possible cost.
C. inefficient since it produces 20 units of output at a cost greater than the minimum cost.
D. inefficient since it produces 10 units of output at a cost greater than the minimum cost.
Answer: B
Blooms: Analyze
107. Refer to the figure below. Suppose that the marginal benefit of writing a contract is $100
and the marginal cost of that contract is $50. Based on this information, the optimal contract
length should:
6-32
A. be increased.
B. be decreased by half.
C. be decreased by two-thirds.
D. be held constant at the contract length where MB = 100 and MC = 50.
Answer: A
Blooms: Analyze
length should be:
A. increased by half.
B. increased by two-thirds.
C. decreased.
D. held constant at the contract length where MB = 100 and MC = 150.
Answer: C
Blooms: Analyze
6-33
length should be:
A. increased by half.
B. increased by two-thirds.
C. decreased.
D. held constant at the contract length where MB = 100 and MC = 100.
Answer: D
Blooms: Analyze
110. Suppose a new contracting environment that requires greater specialized investments is
considered. This new contract will result in:
A. an increase in the marginal benefit and a longer optimal contract.
B. an increase in the marginal benefit and a shorter optimal contract.
C. a decrease in the marginal benefit and a longer optimal contract.
D. a decrease in the marginal benefit and a shorter optimal contract.
Answer: A
Blooms: Analyze
6-34
111. Suppose a new contracting environment that requires less specialized investments is
A. an increase in the marginal benefit and a longer optimal contract.
B. an increase in the marginal benefit and a shorter optimal contract.
C. a decrease in the marginal benefit and a longer optimal contract.
D. a decrease in the marginal benefit and a shorter optimal contract.
Answer: D
Blooms: Analyze
112. Suppose a new contracting environment that requires clearing fewer legal hurdles is
A. an increase in the marginal cost and a longer optimal contract.
B. an increase in the marginal cost and a shorter optimal contract.
C. a decrease in the marginal cost and a longer optimal contract.
D. a decrease in the marginal cost and a shorter optimal contract.
Answer: C
Blooms: Analyze
113. Suppose a new contracting environment with an economic environment that looks more
uncertain is considered. This new contract will result in:
A. an increase in the marginal cost and a longer optimal contract.
B. an increase in the marginal cost and a shorter optimal contract.
C. a decrease in the marginal cost and a longer optimal contract.
D. a decrease in the marginal cost and a shorter optimal contract.
Answer: B
Blooms: Analyze
6-35
114. The presence of substantial specialized investment relative to contracting costs suggests
that the optimal input procurement method is:
A. spot exchange.
C. contract.
D. vertical integration or contract.
Answer: D
Blooms: Understand
Difficulty: 01 Easy
115. The presence of minimal specialized investments relative to contracting costs suggests
that the optimal input procurement method is:
A. spot exchange.
C. contract.
D. vertical integration or contract.
Answer: A
Blooms: Understand
Difficulty: 01 Easy
116. EFI Conveyor Systems recently visited a local AC motor distributor. This transaction
most likely involves:
A. spot exchange.
C. contract.
D. contract or vertical integration.
Answer: A
Blooms: Understand
Difficulty: 01 Easy
6-36
117. Sydney Roofers Incorporated recently purchased 100 pounds of standard roofing nails
from Lowes, a nationwide hardware and building supplies store. This transaction most likely
involves:
A. spot exchange.
C. contract.
Answer: A
Blooms: Understand
Difficulty: 01 Easy
118. General Motors purchased Fischer Auto Body to produce bodies to place on a chassis.
This transaction is best described as:
A. spot exchange.
C. contract.
Answer: B
Blooms: Understand
Difficulty: 01 Easy
119. Which of the following is NOT an implication of specialized investments that lead to
increased transaction costs?
A. Costly bargaining
B. Opportunism and the hold-up problem
C. Underinvestment in specialized investments
D. Incentive contracts
Answer: D
Blooms: Remember
Difficulty: 01 Easy
6-37
120. Piece rates are typically a solution to the:

A. manager-worker, principal–agent problem.
B. manager-owner, principal–agent problem.
C. owner-worker, principal–agent problem.
Answer: A
Blooms: Remember
Difficulty: 01 Easy
121. Time clocks are typically a solution to the:

A. manager-consumer, principal–agent problem.
B. manager-owner, principal–agent problem.
C. consumer-worker, principal–agent problem.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
122. Spot checks are typically a solution to the:

A. manager-consumer, principal–agent problem.
B. manager-worker, principal–agent problem.
C. consumer-worker, principal–agent problem.
Answer: B
Blooms: Remember
Difficulty: 01 Easy
123. The threat of a corporate takeover is an _________ incentive that helps to mitigate the
_________ principal–agent problem.
A. internal; manager-worker
B. internal; manager-consumer
C. external; owner-manager
D. external; owner-consumer
Answer: D
6-38
Blooms: Understand
124. Managerial reputation is an _____ incentive that helps to mitigate the _______
principal–agent problem.
A. internal; manager-worker
B. internal; manager-consumer
C. external; owner-manager
D. external; owner-consumer
Answer: C
Blooms: Understand
125. A decrease in the marginal benefit arising from a specialized investment will cause the
optimal contract length to:
A. increase.
B. decrease.
C. remain constant.
D. either increase or decrease.
Answer: B
Blooms: Analyze
126. An increase in the marginal cost arising from a more complex specialized investment
environment will cause the optimal contract length to:
A. increase.
B. decrease.
C. remain constant.
Answer: B
Blooms: Analyze
6-39
127. A decrease in the marginal cost arising from a less complex specialized investment
A. increase.
B. decrease.
C. remain constant.
Answer: A
Blooms: Analyze
128. Which of the following is NOT a solution to the manager-worker principal–agent

problem?
A. Revenue sharing
B. Profit sharing
C. Time clocks and spot checks
D. The threat of a takeover
Answer: D
Blooms: Remember
Difficulty: 01 Easy
129. Which of the following is NOT a type of specialized investment?

A. Site specificity
B. Physical-asset specificity
C. Human capital
D. All of the statements associated with this question are types of specialized investments.
Answer: D
Blooms: Remember
Difficulty: 01 Easy
6-40
130. Long-term contracts become shorter:

A. when specialized investment becomes less important.
B. when the exchange environment is less complex.
C. when spot markets work poorly.
D. when marginal costs are increasing.
Answer: A
Blooms: Analyze
Difficulty: 03 Hard
131. An increase in the marginal cost arising from a more complex specialized investment
A. increase.
B. decrease.
C. remain constant.
Answer: B
Blooms: Analyze
132. An increase in the marginal benefit arising from a specialized investment will cause the
optimal contract length to:
A. increase.
B. decrease.
C. remain constant.
Answer: A
Blooms: Analyze
6-41
133. Suppose a firm manager has a base salary of $175,000 and earns 0.5 percent of all
profits. Determine the manager's income if revenues are $10,000,000 and profits are
$5,000,000.
A. $150,000
B. $200,000
C. $225,000
D. $300,000
Answer: B
Blooms: Apply
134. Suppose a firm manager has a base salary of $50,000 and earns 2.5 percent of all sales.
Determine the manager's income if revenues are $20,000,000 and profits are $5,000,000.
A. $50,000
B. $175,000
C. $550,000
D. $700,000
Answer: C
Blooms: Apply
135. Suppose a firm manager has a base salary of $85,000 and earns 0.5 percent of all sales.
Determine the manager's income if revenues are $2,000,000 and profits are $500,000.
A. $50,000
B. $87,500
C. $95,000
D. $170,000
Answer: C
Blooms: Apply
6-42

A. 1.5 percent
B. 7.9 percent
C. 10.6 percent
D. 43.4 percent
Answer: C
Blooms: Apply

A. 2.0 percent
B. 13.5 percent
C. 19.6 percent
D. 31.4 percent
Answer: B
Blooms: Apply

millions) = $700. What percentage of the CEO's total earnings is tied to sales of the firm?
A. 5.2 percent
B. 13.5 percent
C. 19.6 percent
D. 33.0 percent
Answer: A
Blooms: Apply
6-43
139. By instituting performance-based rewards to CEOs the profits of firms will:

A. rise.
B. fall.
C. remain constant.
Answer: A
Blooms: Understand
Essay Questions
140. Determine whether the following transactions involve spot exchange, contracts, or
vertical integration.
a. A major oil company refines gasoline from crude oil produced by oil wells that it owns.
b. Transcontinental, an interstate natural-gas pipeline, has a legal obligation to purchase a
specified amount of gas per week from a well owned by Fred Smith in Enid, Oklahoma.
c. A cabinetmaker purchases a dozen wood screws from the local hardware store.
d. An electric utility purchases coal from an underground mine.
Answer:
(a) Vertical integration; (b) contract; (c) spot exchange; (d) spot exchange or contract.
Blooms: Analyze
141. In general, automobile manufacturers produce their own engines but purchase tires from
independent suppliers. Why?
Answer:
Engine manufacturing involves specific investments; by vertically integrating, the potential for opportunism is
reduced. Tires are more uniform and can usually be purchased by spot exchange.
Blooms: Analyze
6-44
142. Which of the following transactions are likely to result in relationship-specific exchange?
a. Purchasing gasoline for the company car
b. Hiring an employee to operate a machine that only your company uses
c. Buying napkins for the company snack bar
d. Purchasing coal for the factory furnace
e. Buying electricity
Answer:
Certainly b, and in some instances, d.
Blooms: Analyze
143. Explain how each of the following affects the optimal method of acquiring an input.
a. A complex contracting environment
b. A specialized investment
c. Opportunism
d. Bargaining costs
e. The costs of bureaucracy
f. Gains from specialization
Answer:
a. Makes contracts a less attractive form of input acquisition.
b. Makes spot exchange problematic, due to opportunism.
c. Leads to more detailed contracts or vertical integration.
d. Leads to longer contracts, or in extreme instances, vertical integration.
e. Reduces the gains to vertical integration and lead firms to use contracts or spot exchange to acquire inputs.
f. Reduces the benefits of vertical integration.
Blooms: Understand
144. Jiffyburger, a fast-food outlet, sells approximately 8,000 quarter-pound hamburgers in a

given week. To meet that demand, Jiffyburger needs 2,000 pounds of ground beef delivered to
its premises every Monday morning by 8:00 A.M. sharp. If you were the manager of a
Jiffyburger franchise, how would you acquire the ground beef? Explain.
Answer:
I would use a contract, since this would decrease the problems of opportunism while still allowing for
specialization in production.
6-45
Blooms: Evaluate
145. Explain why people in the following occupations are compensated as they are.
a. Insurance agents
b. Football players
c. Authors
d. CEOs of major corporations
e. Food servers
Answer:
a. Insurance agents are usually compensated by a fixed base payment and a commission, which is positively
related to the amount of business brought to the company. Without the variable part of salary, insurance agents
have little incentive to find clients.
b. Football players are usually compensated by a fixed payment, along with incentives tied to performance for
reasons similar to the insurance agent example.
c. Authors typically receive royalties, which are revenue-sharing plans whereby the author receives a fraction of
the revenues generated by the book. This compensation scheme provides the author an incentive to write a high-
quality book in order to generate lots of sales for the firm, and thus lots of royalty income for the author.
d. A CEO of a major corporation is usually compensated by a fixed payment plus a variable bonus positively
related to the amount of profits the corporation made. Without the variable part of the payment, the CEO will not
put forth as much effort as desired by the principal.
e. Waiters and waitresses are usually paid a small fixed payment by restaurants. The majority of their pay is
derived from tips, since customers can monitor their servers while the restaurant manager cannot.
Blooms: Analyze
146. A manager derives satisfaction from income and leisure on the job (shirking).
a. If the manager is paid a fixed salary of $100,000, how much leisure will she consume on
the job during an eight-hour day? Explain.
b. When the manager is given a salary of $100,000 plus 10 percent of the firm's profits, she
chooses to spend six hours managing and two hours consuming leisure. Salary and bonus total
$120,000. Does the manager necessarily prefer this situation to the situation in part (a)?
Answer:
a. She will consume the whole eight hours as leisure because working (putting forth effort) causes dissatisfaction
to the manager. Hence the manager will shirk if there is no punishment for doing so.
b. The manager does prefer this situation to the situation in (a). There are two consumption bundles now: (1)
$100,000 salary plus eight hours of leisure a day, and (2) $120,000 salary plus two hours of leisure a day. Since
the original choice of eight hours shirking and $100,000 is still available, the fact that she chose to work two
hours reveals that she prefers the second pay scheme.
6-46
Blooms: Analyze
147. Is it necessarily in the best interests of shareholders for management to ensure that there
is absolutely no shirking in the workplace? Explain.
Answer:
Ensuring absolutely no shirking in the workplace implies very high monitoring costs. There is a trade-off for
shareholders between increasing productivity by reducing shirking and reducing the monitoring costs. The
manager should reduce shirking to the point where the marginal benefit from reducing shirking equals the
marginal cost of reducing shirking.
Blooms: Analyze
148. Discuss the benefits and costs of the following methods of monitoring worker
performance:
a. Hidden video cameras in the workplace.
b. Time clocks.
c. Paying workers based on the output they produce.
Answer:
a. The benefits are that it may be effective. The problem is that it affects the morale of the workers. Moreover,
extra employees are required to watch the video.
b. The major benefit of using time clocks is that they verify that workers show up to work. However, they do not
provide any incentive to work once the workers are at the workplace.
c. The benefits are that the manager can know the performance of individuals. The costs are that it may be costly
to do so, and when the output is completed by teamwork or quality is hard to evaluate, it is difficult to know an
individual worker's performance.
Blooms: Analyze
149. According to Industry Week, a shoe manufacturer recently had a production run that
resulted in 100,000 pairs of defective shoes. Workers on the production line knew the shoes
were defective as they were being produced, but did nothing to fix the problem. Do you think
a profit-sharing plan for workers would mitigate future problems? Explain.
Answer:
6-47
Clearly a profit-sharing reward scheme would have provided workers with an incentive to stop production. The
bottom line is that if managers want workers to produce quality products, they must structure rewards that
promote that goal.
Blooms: Analyze
150. College Retirement Equities Fund (CREF) is a pension fund that has billions of dollars
invested in the stock market. Fund participants recently voted on a proposal that would have
placed strict limits on the amount of compensation paid to CREF executives. Why do you
think 75 percent of the participants voted against the proposal?
Answer:
To the extent that the compensation paid to CREF executives is performance-based, executives receive large
payments only if they are successful in increasing the net asset value of CREF funds. Capping compensation
would thus reduce the executives' incentive to maximize the value of CREF funds, thereby reducing the overall
return to the fund participants.
Blooms: Evaluate
151. Suppose a principal knew with certainty the level of profits that would result if an agent
put forth maximum effort.
a. Would there be a principal–agent problem?
b. Devise two incentive contracts that would induce the manager to put forth maximum effort
in this instance.
Answer:
a. There would not be a principal–agent problem if the principal could devise a contract such that the agent has
no incentive to shirk.
b. Incentive Contract 1: Pay the manager a percentage of profits, provided profits are maximal. Otherwise, pay
nothing to the manager.
Incentive Contract 2: The manager is paid a fixed salary if the profit reaches the maximal profit; the manager is
paid nothing otherwise.
Blooms: Create
Difficulty: 03 Hard
6-48
152. Dallas-based Southwest Airlines recently announced a 10-year contract that gives pilots
a greater opportunity to share in the profits of the airline. According to the terms of the
contract, the pilots will receive options to buy 14 million shares of the firm's stock over the
next 10 years. What impact do you think this new contract will have on Southwest Airlines?
Answer:
The contract provides pilots an incentive to take actions that will enhance Southwest Air's profits. Pilots will thus
be more likely to strive for on-time departures, smooth flights, and to be courteous to passengers.
Blooms: Analyze
153. Art-R-Us makes hand-painted art reproductions. The owner-manager wishes to hire
another artist, and is considering paying a fixed wage plus either (1) a share of the profits
from each painting sold or (2) a fixed payment for each piece produced. Which plan would
you choose if you were the owner? Explain.
Answer:
A share of the profits from each painting sold. Unlike a piece rate, this would provide the artist a greater
incentive to produce high-quality reproductions.
Blooms: Evaluate
154. In a 1998 press release, Boeing Commercial Airplane Group (BCAG) announced that it
was signing a 10-year contract with distributor Thyssen Inc., a distributor of raw aluminum,
valued at approximately $300 million. The contract reflected Boeing's effort to reduce costs
and production bottlenecks resulting from supply shortages. The contract specified prices and
guaranteed quantities of raw aluminum to be delivered to BCAG's suppliers. If you were the
production manager at BCAG, how would you justify the long-term nature of the contact with
Thyssen Inc.?
Answer:
A contract permits it to avoid the hold-up problem in the future, but the trade-off is the uncertainty of the future
economic environment.
Blooms: Analyze
6-49
155. As a manager of the WeDoWell Corporation, you have negotiated with several vendors
and are on the verge of signing an eight-year contract with Bolts Enterprises. Under the
contract, they would ship to you 2,000 titanium bolts per month at a price of $1,000 per bolt.
Your assistant has just brought you an article from a trade publication that indicates another
company has developed a new technology that reduces the cost of producing the titanium
bolts. How would this information affect the optimal length of your contract with Bolts
Enterprises? Explain.
Answer:
The reduction in another supplier's cost of producing titanium bolts reduces WeDoWell's marginal benefit of
contracting. Therefore, the eight-year contract it has been negotiating is too long; the optimal contract length is
now less than eight years.
Blooms: Analyze
156. At the recent shareholders' meeting, the CEO of a small bank proposed a plan to offer
each of its employees 250 incentive options for Class A common stock. The key provisions of
the plan are that employees must exercise the options between January 2014 and December
2019, and if an employee terminates his or her employment with the bank (or is terminated),
the options are no longer exercisable. One shareholder feverishly objected to the plan,
claiming that such a move would dilute the value of the outstanding shares. As CEO, how
would you defend the stock option plan to the shareholders?
Answer:
The first important point to make with the shareholders is that this incentive plan is designed to maximize
shareholder value. This is achieved by giving employees an incentive to stay with the company longer, thereby
reducing costly employee turnovers and increasing the company's profitability. Also, by using the stock options
as an incentive plan, employees will want to find ways to work more productively and make the company more
profitable. The benefits to the shareholders and the employees will be a higher stock price.
Blooms: Evaluate
Difficulty: 03 Hard
157. You are the manager of Door-to-Door Vacuum Cleaners, Inc. Each salesperson is paid a
base salary plus a percentage of the revenues she or he generates. In addition, each
salesperson drives his or her car to and from each sales call and is reimbursed $0.40 per mile
driven. On average, each salesperson drives about 150 miles per day and 240 days per year.
As manager of Door-to-Door, how might you restructure the compensation of your sales force
to enhance your profits? Are there any potential disadvantages of your plan? Explain.
Answer:
6-50
The manager might pay a salesperson a base salary plus a percentage of the profits. This plan would penalize
salespersons, to some extent, for excessive mileage.
Blooms: Evaluate
6-51

Baye 9e - Chapter 06 - TB

Uploaded by

Copyright:

Available Formats

Baye 9e - Chapter 06 - TB

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Baye 9e - Chapter 06 - TB

Uploaded by

Copyright:

Available Formats

Chapter 06 - The Organization of the Firm

Multiple Choice Questions

2. Which of the following forms of payment is NOT an incentive plan?

4. Which of the following is NOT a means of avoiding opportunism?

5. Long-term contracts become longer:

6. A relationship-specific exchange occurs when:

7. When relationship-specific exchange occurs in complex contractual environments, the best

Topic: Optimal Input Procurement

8. A firm might choose to produce its own inputs if:

10. Spot exchange can be inefficient in the presence of:

11. A negative side of long-term contracts is:

13. The disadvantage of vertical integration is that:

14. In the absence of worker incentives:

AACSB: Knowledge Application

16. A drawback of separating ownership from control by creating a firm is:

17. Shirking can take the form of:

20. Suppose compensation is given by W = 512,000 + 217π + 10.08S, where W = total

21. Suppose compensation is given by W = 512,000 + 217π + 10.08S, where W = total

22. An incentive for managers to maximize profits is:

26. A negative side of a revenue-sharing plan is that it:

27. Which of the following is NOT an example of a piece-rate compensation method?

Topic: The Manager-Worker Principal–Agent Problem

28. A potential problem with piece-rate plans is that:

30. In order for spot checks to be effective, they must be:

31. Which type of compensation mechanism works by threats?

32. Which type of compensation method works by performance bonus?

AACSB: Knowledge Application

35. To ensure quality, piece-rate plans must usually be accompanied by:

36. Transaction costs refer to:

37. Spot checks:

38. Spot checks work because of:

39. An increase in the likelihood of a dismissal:

40. High transaction costs:

41. Long-term contracts are NOT efficient if:

AACSB: Knowledge Application

42. Which of the following occurs as firm size grows?

44. Which of the following mergers is an example of vertical integration?

48. The agent is an individual:

50. Principal–agent problems do NOT arise between:

AACSB: Knowledge Application

53. Specialized investments:

54. Vertical integration:

55. If a manager is not the owner, the manager:

56. When the owner runs the business:

57. A long-term contract:

59. A firm chooses the institution to purchase inputs:

61. A firm manager is an agent hired by the:

62. The principal–agent problem happens because the owner cannot:

AACSB: Knowledge Application

63. Spot exchange typically involves:

64. Long-term contracts:

66. Relationship-specific investments include:

67. One way of alleviating opportunism is:

69. Which of the following institutions may result in hold-up?

AACSB: Knowledge Application

70. Relationship-specific exchange:

71. Long-term contracts are LESS likely when:

72. Under a profit-sharing compensation scheme, the manager will:

75. Franchising mitigates: