Question

The owner of a thriving business wants to open a new office in a distant city. If he can hire someone who will manage the new office honestly, he can afford to pay that person a weekly salary of $2,000 ($1,000 more than the manager would be able to earn elsewhere) and still earn an economic profit of $500. The owner's concern is that he will not be able to monitor the manager's behavior and that the manager would therefore be in a position to embezzle money from the business. The owner knows that if the remote office is managed dishonestly, the manager can earn $3,500, which results in an economic loss of $400 per week. (Hint. Construct a decision tree to help you answer the questions below.) a. If the owner believes that all managers are narrowly self-interested income maximizers, will he open the new office? O Yes O No b. Suppose the owner knows that a managerial candidate condemns dishonest behavior, and who would be willing to pay up to $5,000 to avoid the guilt she would feel if she were dishonest. Will the owner open the remote office? O Yes O No

Answer 1

a. If the owner believes that all managers are narrowly self-interested income maximizers, he would not open the new office. This is because if the manager is dishonest, he or she would earn $3,500, resulting in an economic loss of $400 per week. However, if the manager is honest, the owner would pay $2,000 per week and still earn an economic profit of $500. Since the manager's income-maximizing strategy would be to embezzle money, the owner would expect the manager to behave dishonestly and would not be able to monitor the manager's behavior, so the owner would not open the new office.