UF II Midterm Minarikova Dana

Guess 2/3 of the average

Describe shortly the game "guess 2/3 of the average".
If all of the players were Homo Economicus, what would the result be, and why?
How do the results in real world experiments differ from the homo-economicus optimum
discussed above? Why?
In the game "guess 2/3 of the average" each person has to choose a real number between 0 and 100.
The winner is the one who chose the closest number to 2/3 of the average of all numbers chosen.
If all the players were Homo Economicus the result would be 0. E.g. If you expect the average
number to be 50, 2/3 of it would be 33,33, but since you would expect the other players to think the
same, you go with 2/3 of 33,33 and so on, until you are at 0.
In real world experiments the results use to be less rational and mainly the "players" don't anticipate
the rationality of the others in such an extreme way.

Ultimatum game
Describe shortly the Ultimatum Game.
What would be the outcome of the game if both individuals were homo economicus?
What are the outcomes of real-world experiments of the ultimatum game? Name some of the
factors that influence the ampunts offered and the rejection rates.
The Ultimatum Game is played by two players: a Proposer and a Responder.
The Proposer can propose the division of a good to the Responder.
If the Responder accepts the offer he gets what the proposer offered him, if he rejects nobody gets
anything.
If both individuals were homo economicus the proposer would offer the smallest division possible
and the Responder would accept it, since the smallest amount of anything is better than nothing!
In real-world experiments the division of the good would be more equal. There are different factors
influencing the results, e.g. the reputation (btw observation), gender, social class/group, amount of
the good etc..

NGO donation form

Imagine you work for an NGO and your current task is to design a donation form – a document
where people will fill out the sum of money they would like to donate to your company.
How could you design the form so that people will donate more money thanks to the anchoring
effect?
According to the Anchoring effect in example with donations: average donations of recipients who
gets letters with a higher requested amounts will be more than the other group who gets requests
with a lower sums even if the texts of letters will be identical.
Example:
We need your help to save one more young life and give a hope to other kids who are fighting with a
worth anamy of their lifes. HELP them to overcome CANCER. Every donation is one step to the goal.
How big it will be is up to you.
50$ 70$ 100$ other amount

Heuristics
Describe shortly the following heuristics: availiability h., representativeness h., familiarity h.
Give one concrete example of a real life behavior for each of them.
Heuristic is a mental shortcut that help us make decisions and judgements quickly (without spending
a lot of time and analysing information)

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Availability Heuristic is a mental shortcut that realize on immediate example that comes to a given
persons mind when evaluating a specific topic. We ignore a statistic. Example: we believe that shark
is more dangerous than a cow. In reality annual more people die from the attack of cows rather than
sharks.

Representativeness Heuristic is a mental shortcut which helps us make a decision by comparing

information to our mental prototypes. Example: if you see an old woman on the playground who is
kind and caring with a great love of children most of us will assume that she is a grandmother. She
fits to the mental representation of a grandmother so we automatically classify here into this
category.

Familiarity Heuristic is behaviour in prevailing circumstances, based on the knowledge or similar

experience in the past. They may regress back to the state of mind in which they have felt or
behaved before. Example: children would rather prefer a pizza than a soup for a dinner.

Hidden job market

According to a recent statistics, 50-70% of the open positions in Austria are not publicly advertised.
What are the advantages and disadvantages of hiring an acquaintance/recommended candidate
compared to advertising the job offer publicly (from the point of view of the company)?
Hidden Job Market means that job offers are not published because many of the companies want to
hire known or proposed people.

Advantages of the hiring recommended candidates

1) It saves time and money. Moreover, even when posting a job online for free, recruiting managers
get overwhelmed by the huge amount of unqualified applicants that reply. Employers end up
spending so much resources and hours screening every candidate.
2) Hiring some definite person for a particular vacancy you know that her adaptation in your
business will be fast and less harmful. Hence you can expect a productivity phase in short period of
time.
3) Looking for a candidates through your own network minimize asymmetric of information about
candidate (adverse selection)
Disadvantages of the hiring recommended candidates
1) Well qualified, demanded person with experience might cost to enterprise more.
2) An employee from familiar environment would probably notified with an internal Information as
well.
3) If the cooperation not successful it will be more problematic (from moral point of view) to
dismiss an employee.

St. Petersburg Paradox

Describe shortly the fair-coin-toss game played in the St. Petersburg paradox. What is the expected
value of the game (lottery)? What yould you be willing to pay for this lottery? Is this more or less
than the expected value of the lottery? Why?
The St. Petersburg game is played by flipping a fair coin until it comes up tails, and the total number
of flips, n, determines the prize, which equals $2n. Thus if the coin comes up tails the first time, the
prize is $21 = $2, and the game ends. If the coin comes up heads the first time, it is flipped again. If it
comes up tails the second time, the prize is $22 = $4, and the game ends. If it comes up heads the
second time, it is flipped again. And so on. There are an infinite number of possible ‘consequences’

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The second part of the question I would like to willing to play this game if I would be a risk-seeker
Signaling and screening
What is the difference between signaling and screening? Give two examples of each.
Signaling is an actions of that party which is more informed. They provide information on its own to
the market. As they possess with a hidden information signalling party is more active than screening.

Screening is less informed party who is trying to get more information before making decision. They
have to outsource a lot of information to define the most important one.

Examples
Signaling: 1) newly graduated Student is applying for a job. He posts as much as possible different
diplomas, rewards and other experiences signalling and spreding Information about himself. 2) a new
product line of pure organic Bio milk will “signaling” about it with information and different
certificates on the glass bottle. The company will try as much as possible to show the difference with
a standard milk approving the importance of healthy organic bio milk.
Screening: 1) a HR Manager of the company organises job interviews and other tests as well as
probationer period in order to find a best suitable employee on the vacant job place. 2) Mom of 2
month old baby is looking for an organic bio milk best quality to provide a best nutrition. That`s why
she is searching and testing all possible big concerns and private farms in Austria.

Bob van der Builder

Bob van der Builder is an electrical engineer. There are two possible career options in this field. On
the one hand, Bob can find a job as an employee in a successful engineering office and earn a
yearly wage of € 75.000. The industry is quite stable, so the risk of losing the job is almost
negligible. On the other hand, he can start his own engineering company and try to earn his money
by being self-employed. This option is risky and Bob’s success is not guaranteed. After a discussion
with several experts from the field, he judges the possible developments of his firm as following.
With the probability 20% the company will be highly successful and he will earn a yearly profit of €
250.000. With the probability of 50%, the company will survive throughout the years and earn €
80.000 yearly. Finally, with the probability 30% the company goes bankrupt and earns € 0 (in this
simple example we ignore the possibility of starting a different job after the bankruptcy – let’s say
Bob is frustrated and does not want to work anymore).

Think of this decision between career options as a decision between a lottery and a sure payment.
Let’s assume that both types of career (employed and self-employed) are equally appealing to Bob,
the only difference is the monetary expectations and the risk.

a) What is the expected yearly income from being self-employed?

b) If Bob is risk-seeking, which career option will he choose?
c) If he is indifferent between employment and self-employment, what is his risk-attitude?

a) Expected yearly income from being self-employed is EUR 90 000

b) If he is risk-seeking Person he will choose self-employment
c) If he is indifferent to the career he is risk-neutral

Lotteries (1)
A rational decision maker can choose between a lottery with an expected value E(L) = 50, and a
sure payment SP = 55.

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1) When he is risk neutral, what will he prefer?

2) When he is risk seeking, what will he prefer?
3) When he is risk averse, what will he prefer?
4) If he prefers the lottery to sure payment, what is his risk attitude?
5) If he prefers the sure payment to the lottery, what is his risk attitude?

1. He will prefer the SP.

2. He will prefer E(L).
3. He will prefer the SP.
4. Because the SP is higher than the Lottery (55>50), it is irrational behavior, if he prefers the L over
the SP. And risk seeking, risk neutral and risk averse are risk attitudes only for rational behavior. So in
this case he is none of them, he is just irrational.
5) If he prefers the SP he is rational. But because it it is obvious to choose the SP, because in every
case you are better off with this choice, he can be risk neutral, risk seeking or risk averse. We can not
say what he is, he can be risk. averse, seeking or neutral.

Rationality
What is the difference between rationality and bounded rationality?
Give some examples of a rational behavior, boundedly rational behavior, and irrational behavior.

Rational Behavior: Individuals with clear set of preferences, making optimal decisions to achieve
their goals.
In order to do so, they need to know all available alternatives and each of their consequences. To be
able to evaluate the consequences objectively, they must have a well- ordered and stable set of
preferences.
Example: Prisoners Dilemma
Alternatives: cooperate or not cooperate
Consequences: Outcomes (years of prison)
Preferences: Least favorable=longest time in prison - most favorable: least time in prison

Bounded: Human beings are limited in their cognitive capacities, time and information. Therefore,
people can not always make optimal (rational) decisions. They are using heuristics - as mental
shortcuts - to find the best possible decision within their restrictions.
Example: Late for your own bbq party and you are missing ketchup. You arrive in the supermarket at
19:55. Unfortunately, your supermarket offers many different variations/brands.
Use of i.e. familiarity heuristic: I already tried the Heinz BBQ sauce and it was amazing --> I'm gonna
take the Heinz Ketchup.

Meeting
Three colleagues want to arrange a meeting. Assume that the (monetary) utility functions of the
colleagues are known, with h being the time of the day:
Krusty: UK(h) = -h2 + 16h + 200
Lisa: UL(h) = -2h2 + 36h + 100
Marge: UM(h) = -h2 + 28h + 100

1. Compute the optimal meeting time for each of them and draw them in a graph.

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2. A secretary arranged the meeting to take place at 12:00. Is this date pareto-efficient? Are
there other pareto-efficient dates? If yes, which?
3. Now they want to arrange an optimal time themselves by choosing the time which
maximizes the total utility of the group. First, write down the total utility function of the
group. Then compute the optimal meeting time and draw the total utility function with the
optimal time in the graph.
4. Show in the graph the utility difference for Marge between the new (optimal) decision
compared to the secretary decision before.
1)
K: h*=8
L: h*=9
M: h*=14

2)
The 3 utility functions are downward sloping parabolas --> i.e. for L the optimal time is 09:00, from
00:00 to 09:00 utility is increasing and after 09:00 it is decreasing (same for K h=9 and M h=14)

Therefore, 12:00 must be Pareto-Efficient since non of them could increase their utility without
letting anyone else worse off.

IMO this holds for every time between h>=8 and h>=14

3)
Total: U= (200 + 16 h - h^2) + (100 + 36 h - 2 h^2) + (100 + 28 h - h^2) = -4 h^2 + 80 h + 400
--> h*=10

Financial fraud
A financial auditor Mr. Ambrosius gets the following question:
It is well known that many cases of management fraud go undetected even when competent
annual audits are performed. The reason, of course, is that Generally Accepted Auditing Standards
are not designed specifically to detect executive-level management fraud. We are interested in
obtaining an estimate from practicing auditors of the prevalence of executive-level management
fraud as a first step in ascertaining the scope of the problem.
1. Based on your audit experience, is the incidence of significant executive-level management
fraud more than 10 in each 1,000 firms (that is, one percent) audited by Big Four accounting firms?
a. Yes, more than 10 in each 1,000 Big Four clients have significant executive-level management
fraud.
b. No, fewer than 10 in each 1,000 Big Four clients have significant executive-level management
fraud.
2. What is your estimate of the number of Big Four clients per 1,000 that have significant
executive-level management fraud? (Fill in the blank below with the appropriate number.)
_________ in each 1,000 Big Four clients have significant executive-level management fraud.

His colleague, Ms. Bertha gets the same question, except in question 1 a. and b. the number
indicated was "more/fewer than 200 in each 1,000 Big Four clients".

• Which of the two financial auditors is more likely to answer with a higher number in
question 2?

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• Why? What is this effect called?

• Explain how the effect works in general.

- more likely that Ms. Betha answered with a higher number on question 2. Because the sudgested
number "200" will work as an Anchor.
- This is Anchoring Effect.
If you make an assumption using some fake number or a date or Y/N answer it effects as an
“Anchor” on the responder. Its very hard to avoid its` influence. The answer of responder would be
closer to your suggested number even if the real answer is absolutely different. Your assumption
about the answer on requested question works as an Anchor.

Oil drilling
Oil drilling is an economic activity that requires large sums of money being invested for
exploration, building, and machinery. However, an oil well is much less valuable if there is no
pipeline that will ship the oil from the well to the refinery. Once an oil well is established, a firm
that builds a pipeline has a huge bargaining power and can buy oil from the drilling company at a
very low price. However, reasoning backwards, the oil well owners know that if they don't have
control over the prices offered to them by the pipeline builders, they will not be likely to recover
their fixed costs of investment. Therefore, they will not invest.
a) What is this problem called?
b) Suggest possible solutions to this underinvestment problem.

This is a Hold up Problem. A situation where 2 parties may be able tp work most efficiently by
cooperation but refrain from doing it because of concerns that they may give to other party increase
bargaining power and thereby reduce their own profit.

The best way to find a common solution(price) and provide a fare profit for both of them. Otherwise
both company wont survive. That leads to underinvestment in economic

Incomplete contracts
What is a complete contract? What are the reasons for incomplete contracts?
Explain why the contract between you and the University of Vienna about your studies is an
incomplete contracts (with some examples).
You can also write other examples of incomplete contracts (with an explanation of why they are
incomplete).
Writing a contract people can not spacified everything in it what is relevant for economical
relationship. Basically both parties can not predict all controversial cases from the future that why
they make incomplete contract with possible additions in the future concerning appeared situation.

If the parties to an agreement could specify their respective rights and duties for every possible
future state of the world, their contract would be complete. There would be no gaps in the terms of
the contract. But such kind of contracts would be very expensive, allmost impossible and irrational to
create.

My contract with University is incompleted. There is not all possible scenarios of future
developments mentioned.

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A useful signal?
Johnny is considering whether to obtain a PhD degree in Chemistry. He already has a master
degree, which was quite easy to obtain, because there is a lack of students who want to study
chemistry and the university is glad to accept even the less clever ones. Johnny likes chemistry and
wants to work in that field for sure - but does not want to stay in academia. The PhD in chemistry
is really hard to obtain, but Johnny is a quick-learning and enthusiastic student. He can also decide
to start working straight away in a cosmetics producing company in his town, they would hire him
as a lab assistant. If he continues his specialization and obtains a PhD, the company would gladly
accept him to a higher positon than with a masters degree, also with a double salary.
1. What are the properties of a useful signal? (just list them)
2. Now, analyze Johnny’s decision from the signaling perspective: is obtaining a PhD a useful
signal to the job market? (Evaluate whether it fulfills the properties of a useful signal you
listed above)
1. The properties of a useful signal are: Informativeness, Costs of obtaining the signal and ROI of the
signal.
2. The Cost of obtaining the signal will be very high, because he has to study (no money) instead of
working, where he would get a good salary. But in my opinion the signal is still worth it, because the
ROI of the signal are in the long run much higher. He will get paid twice as much, so if he has to study
for X years for his PhD, he will break through after X/2 years. After that time period the signal will
constantly pay off. And because he will earn twice as much after getting his PhD, the informativeness
is given as well.
So in the light of the mentioned facts, it is useful to obtain the PhD.

Insurances
Insurance companies in some countries offer discounts for the customers who accept to have their
behavior monitored. For example, car insurance is cheaper if you allow the insurance company to
install a monitoring device in your car, which can control your driving behavior, and your discount
is based on this behavior. In the health insurance sector, cusomers have the possibility to reduce
their insurance premium if they let the insurance company monitor their fitness and diet habits.
1. What are the benefits of such insurance type to the insurance companies? (Why do they
offer them?)
2. What are the pros and cons of such an insurance to the customers?
3. Based on the answer from 2., would you enter such an insurance (if it would be offered in
your country)?

1- the Main task of insurance companies is obtaining a information about a person or in this case car.
In order to avoid insurance frauds. People more likely to be careful when they are watched by a
company.
2- Pros: can get higher insurance payments with cheaper price
Cons: People who are already diseased or not healthy as others can get lower premiums from
insurance companies
3- No I don't want to get insurance such as because being monitoring is disturbing some way due to
privacy

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Effectiveness and Efficiency

What is the difference between effectiveness and efficiency?
Give one example of a situation, where something is:
a) efficient as well as effective
b) neither efficient nor effective
c) efficient but not effective
d) effective but not efficient

Effective means produce at high level whereas efficiency produces quickly solution. Combining those
two terms means for a company; produces better products faster and with fewer resources.

A- Buying at a fast and safe car for a cheap price to drive quickly to get location
B- Buying a damaged car for a expensive price
C- Buying a usual car for a cheap price (producing in a cheaper way)
D- Buying a fast car for a expensive price (producing a higher cost but maximizing a value)

Heuristics 2
Decide, whether the following situations represent an example of [single choice]:
a) availability heuristic
b) representativeness heuristic
c) familiarity heuristic

Situation 1
Sarah loves to listen to New Age music and faithfully reads her horoscope each day. In her spare
time, she enjoys aromatherapy and attending a local spirituality group. Based on the description
above, people think that Sarah is more likely to be a holistic healer than a teacher.

Situation 2
After seeing news reports about people losing their jobs, you might start to believe that you are in
danger of being layed-off. You start lying awake in bed each night worrying that you are about to
be fired.

Situation 3
You read an article about lottery winners. After that you start to overestimate your own likelihood
of winning the jackpot. You start spending more money than you should each week on lottery
tickets.

Situation 4
Patients are more likely to take medicine and pursue treatment options that have worked in the
past, whether they are effective in the current situation or not. This also extends to treatments the
patient has not used before but has heard about. For example, a lay person may request a name-
brand medication because they have heard of it before, even though a generic drug may be
essentially the same but less expensive.

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Situation 5
In a series of 10 coin tosses, most people judge the series HHTTHTHTTH to be more likely that the
series HHHHHHHHHH (where H is heads and T is tails), even though both series are equally likely.
The reason is that the first series looks more random than the second series.

Situation 6
In a 2010 study exploring how vivid television portrayals are used when forming social reality
judgments, people watching vivid violent media gave higher estimates of the prevalence of crime
and police immorality in the real world than those not exposed to vivid television. These results
suggest that television violence does in fact have a direct causal impact on participants' social
reality beliefs. Repeated exposure to vivid violence leads to an increase in people's risk estimates
about the prevalence of crime and violence in the real world.

1) Representativeness heuristic
2) Availability heuristic
3) Availability heuristic
4) Familiarity heuristic
5) Representativeness heuristic
6) Availability heuristic

Moral hazard / adverse selection / hold-up ???

Decide, whether the following situatuions are examples of (MULTIPLE CHOICE):
• moral hazard
• adverse selection
• hold-up problem

Situation 1:
Consider a hypothetical strawberry farmer who has to spend a large sum of money to grow
strawberries. If the only source of labour is a labour union, the farmer may face a difficult situation
when it is time to pick and sell his strawberries. The union can take advantage of him by asking a
total wage payment equal to the market value of strawberries minus transportation costs. The
farmer with ripe strawberries will have no choice but to say yes! However, reasoning backwards,
the farmer will see this and not grow strawberries unless he can prevent being taken advantage of
at the end.

Situation 2:
Rudolph is a bad driver. He knows he cannot estimate distances very well and has already often
bumped into other cars when parking. Therefore he buys a car insurance which covers all the
damage caused (to his or to others’ cars). Now that he is insured, he sometimes tries to park the
car with his eyes closed.

Situation 3:
Edward is a top manager of an international logistic company – it is a publicly traded company held
by dispersed shareholders. Edward has been in the position for 5 years now, and he enjoys his job
very much. The company has suffered some losses in recent years, partly because Edward
suggested investing in some risky projects. He wanted to increase short-term profits in order to
increase his yearly bonus.

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Situation 4:
Both oil drilling and refining are economic activities that require large sums of money being
invested for exploration, building, and machinery. However, an oil well is much less valuable if
there is no pipeline that will ship the oil from the well to the refinery. Similarly, a refinery is useless
if it has no oil to process. Once wells and refineries are established, operating costs are not large.
Therefore, a firm that builds a pipeline can buy oil at a low price from the well owners, and can sell
it at a high price to the refinery owners. This will reduce the profitability of investing in the wells
and refinery. (Pipelines are natural monopolies, and therefore there will be no competition to
prevent this.) However, reasoning backwards, both the oil well owners and the refinery owners
know that if they don’t have control over the prices offered to them by the pipeline, or the price
charged by the pipeline, they will not be likely to recover their fixed costs of investment.
Therefore, they will not invest. The possibility that investors in the oil wells and refineries will not
be able to recover their investment may result in no investment being made.

Situation 5:
Fiona is an owner of a corn farm. She does not manage to harvest the farm by herself, so she
decides to hire two workers to help her plant and harvest the corns. After a few days she finds out
that her employees spend a lot of time chatting instead of harvesting, and they even eat some of
the corns they should harvest.

Situation 6:
An insurance company offers a car theft insurance. They know that on average 1 car in 10,000 gets
stolen per year and they set the price to be the expected value of a car to be stolen in the country
(price x average probability of a car being stolen). After a year, they find out that from the cars
they insured 100 out of 10,000 were stolen.

Situation 7:
An investment bank offers a position as an investment banker. The job requires the employee to
invest in risky assets and his salary will depend on the success of these investments. The
responsible manager interviews 10 applicants for the position, and he finds out that all of them are
very risk seeking.

1) hold up (specific investment -> bargaining power, underinvestment)

2) moral hazard (drives blindly) + adverse selection (bad driver)
3) moral hazard
4) hold up problem
5) moral hazard
6) moral hazard + adverse selection (although not directly mentioned, as discussed in class:
insurance attracts a subset of population for which this insurance is beneficial = adverse
selection, after insured they care less = moral hazard)
7) Adverse selection

Moral hazard and adverse selection

What is moral hazard? What is adverse selection?
Give some examples of situations, where moral hazard and adverse selection occur together (with
explanation which is which).

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Adverse selection is a pre-contractual form of disorganisation of the market, where its` participation
is affected by asymmetric information. Trades who possess with more information about product will
selectively participate in trades wich benefit them the most.

Moral Hazard is a contractual form of disorganisation of the marker. It occurs when there is
asymmetric information between two parties and change in behaviour of one party after a deal is
struck.
Example: you drive to repair your car. You have no idea what`s happened. The mechanic says that
you need to change carburettor. The mechanic knows much more about cars than you that`s why
you don’t know whether he is correct or even if he says a truth (example of asymmetric information
which leads to adverse selection ). During these days mechanic decided to visit his girlfriend in the
next city. He took your car to do it before taking it back to you (example of moral hazard)

The Fellowship Ltd.

Two colleagues Aragorn (A) and Bilbo (B) are discussing a possible investment in a joint venture;
they would invest in assets which are completely cospecialized and have no value outside of this
investment. They initially agree on the terms of profit sharing (40:60). However, it is not possible
to close an enforceable (complete) contract about the division of the profit. Both of them have the
possibility to hire lawyers and engage in costly legal procedures in order to increase their share of
the investment return. In the following payoff matrix, you can see the payoffs for Aragorn and
Bilbo in the four possible cases: each of them can decide to “grab” (hire lawyers and increase their
profit shares) or “don’t grab” (no legal procedures).
The payoffs [in thousands of $] are plotted in the form: (payoff for A, payoff for B).
A
Grab Don’t Grab
Grab (-1, -2) (-5, 8)
B
Don’t Grab (9, -7) (4, 6)

1.1) What is the optimal action of A when B grabs? Why?

1.2) What is the optimal action of A when B doesn’t grab? Why?
1.3) What is the optimal action of B when A grabs? Why?
1.4) What is the optimal action of B when A doesn’t grab? Why?
2) What will A and B do in the Nash-Equilibrium? What are the payoffs?
3) Would they decide to invest in this joint project? Why/why not? (compare the expected
payoffs with and without the investment)

1.1) the optimal action for A when B grabs would be to grab as well. In this case A will get -1. This is
the most positiv outcome in this case.
1.2) the optimal action for A when B doesn’t grab is to grab. Profit for A in this case = 9. But you for
sure meant the right thing, because the 9 is correct.
1.3) the optimal action for B when A grabs is to grab as well. A losses for B will be -2
1.4) the optimal action for B when A doesn’t grab is to grab es well. Profit of B is 8

2. The Nash Equlibrium is (-1, -2).

3. Because they would loose money (A: -1000€ and B: -2000€), they will not invest. If they don't
invest, they will have 0€ wins, but also no losses.

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Utility functions
Think about how the following utility functions might look in a graph and draw them:
1. The utility of monthly income
2. The utility of chocolates you ate in one day
3. The utility of chocolates you ate in one day if you are allergic to chocolate
4. The utility of work effort in a job you enjoy
5. The utility of work effort in a job you hate
6. The utility of a mother derived from her child’s well-being
è Siehe Ausdruck

Managerial misbehaviour
Explain why in companies with dispersed ownership (when the company is owned by a lot of small
shareholders and governed by appointed executive managers) there is a risk of managerial
misbehavior?
What are the possible actions of moral hazard that the top managers of the company can take?
(you may also list some publicly known cases)
How can hostile takeovers possibly mitigate such managerial misbehavior?

The problem that leads to managerial misbehavior in companies with dispersed ownership is the
separation of ownership and control. Since there are only individual small shareholders noone does
monitor the managers and they can take advantage of it e.g. by decreasing their effort, taking more
risk etc.
This kind of moral hazard happened e.g. to Lehman Brothers, Enron, Worldcom etc.
Possible solutions to this problem are e.g. the acquisitions of shares to make controlling ownership
possible, replacing the senior management by new owners etc.

Lotteries (2)
A decision agent has a choice between a lottery (L) and a sure payment (SP).
1. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $90. If he prefers the lottery to the sure payment,
he is _______________________.
2. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $75. If he is indifferent between the lottery and
the sure payment, he is _______________________.
3. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $40. If he prefers the sure payment to the lottery,
he is _______________________.
4. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $71. If he prefers the sure payment to the lottery,
he is _______________________.
5. The lottery has three possible outcomes: $50 with the probability of 50%, and $100 with
the probability of 20%, and $200 with the probability of 30%. The sure payment is $110. If
he prefers the lottery to the sure payment, he is _______________________.
6. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $75. If he prefers the sure payment to the lottery,
he is _______________________.

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UF II Midterm Minarikova Dana

7. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $130. If he prefers the lottery to the sure payment,
he is _______________________.
8. The lottery has two possible outcomes: $50 with the probability of 70%, and $120 with the
probability of 30%. The sure payment is $71. If he is indifferent between the lottery and
the sure payment, he is _______________________.

1. risk seeking
2. risk seeking, since SP>E[L]
3. irrational
4. risk averse
5. risk seeking
6. he could be anything (r. averse/neutral/seeking) - because the sure payment is higher than the
expected value of the lottery, we do not know whether he chose it because of the (lower) risk or
because of the expected value
7. irrational
8. risk neutral

Probationary period
You want to hire a fresh graduate on a free position in your company. However, due to the lack of
his previous work experience you cannot assess his productivity correctly with a job interview and
you decide to hire him for a probationary period.
Draw a possible compensation scheme for such a probationary period.
What are the advantages of a probationary period? When is it beneficial to use it?

Possible compensation scheme (if I understood the question correctly):

Ø Employers should clearly set out what terms do and do not apply at this time.
Ø It is common for employees not be enrolled in benefits schemes until completion of the
probationary period.
Ø Holidays accrue and employees are entitled to the national minimum wage and statutory sick
pay.
Ø They will still be obliged to grant family-related leave, recognise pregnancy and maternity
rights and consider reasonable adjustments for disabled employees on probation.
Advantages of Probationary Period
Ø it is a useful tool to manage new or newly promoted employees
Ø it allows both you and them to make sure that you have made the right decision and you are
setting a clear expectation with them
Ø ability of an employer to evaluate employee performance without significant risk
Ø employer is capable to terminate the employee without repercussion during the evaluation
term
Ø an employer need not make a significant financial investment (benefits for example) in an
employee until the examination period ends.

It would be beneficial for the employee and employer to assess the suitability of the role after having
first-hand experience. On the one hand, it gives the employer opportunity to assess objectively
whether the new employee is suitable for the job taking into account their capability, skills,
performance, attendance and general conduct. On the other hand, it gives the new employee the
opportunity to see whether they like their new job and surroundings.

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