Compensation Incentives Essay

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TOPICS VISITED
CASE SITUATION
NEW DEFINITION OF FIRM
INCENTIVE CONFLICTS BETWEEN MANAGEROWNERS
CONTROLLING INCENTIVE CONFLICTS
CASE STUDY ANALYSIS

CASE SITUATION BREAKDOWN
Owner of a small chain of five restaurants in Oregon, U.S.
All locations are close enough for you to be actively involved in each firm, with a head manager acting at each location.
Opportunity for an expansion location, 750 miles away from current locations in Salt Lake city.

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A less traditional approach to defining a firm is required when analyzing organizational issues within it.

A definition that is useful for particularly our case is that; “A firm is a focal point for a set of contract's”
(Brickley, J., Smith, C., & Zimmerman, J. 2009)

INCENTIVE CONFLICTS BETWEEN
MANAGERS AND OWNERS
SINCE WE AS INDIVIDUALS ARE NATURALLY MOTIVATED TO
MAXIMIZE OUR OWN UTILITY, OUR OBJECTIVES ARE NOT USUALLY
AUTOMATICALLY ALIGNED WITH THOSE OF THE FIRM.
THREE MAIN INCENTIVE CONFLICTS THAT ARISE PARTICULARILY
BETWEEN OWNERS AND MANAGERS OF A RESTAURANT
1) DIFFERENTIAL HORIZONS
2) PREREQUISITE TAKING
3) CHOICE OF EFFORT

DIFFERENTIAL HORIZONS
THIS INCENTIVE CONLFICT DEPICTS THAT A MANAGERS SAY ON CERTAIN ISSUES ARE LIMITED
TO THE TENURE OF THEIR EMPLOYMENT. WHEREAS MOST MANAGERS IN RESTAURANTS HAVE
LITTLE TO NO INVESTMENT IN THE COMPANY, ATTENTION TO CASH FLOWS AND OTHER
FINANCIALS CAN BE LIMITED TO THEIR CONDITIONS THEREFORE IT IS IMPARATIVE IN THE
RESTAURANT INDUSTRIES TO MAINTAIN A CONTRACT THAT ALLIGNS INCENTVIVES

PREREQUISITE TAKING
OWNERS SHOULD NOT ONLY PAY SUFFICIENT SALARIES TO ATTRACT COMPENTANT MANAGERS
BUT ON TOP OF THE DEMAND FOR HIGH SALARIES FROM MANAGERS, PREREQUITES ARE
HIGHLY SOUGHT AFTER AS WELL. THIS WOULD INCLUDE LAVISH OFFICE FUNITURE, GOLD
MEMBERSHIPS, ETC. IN THE RESTAURANT INDUSTRY, MANAGERS WOULD OFTEN REQUIRE A
SEPARATE FURNISHED OFFICE TO PERFORM DAILY BUSINESS TASKS AS WELL AS AN AREA TO
ENTERTAIN AND MINGLE WITH FOOD/ALCOHOL SUPPLIERS.

CHOICE OF EFFORT

IN MOST CASES ADDITIONAL EFFORT BY MANAGERS IS POSTIVELY RELATED TO THE VALUE OF
THE FIRM INCREASING IT RELATIVE TO EFFORT. THE INCENTIVE PROBLEM THAT WE FACE HERE
IS THAT ADDITIONAL EFFORT REDUCES THE UTILITY OF THE MANAGER WHILE IT INCREASES
THE VALUE OF THE FIRM. THEREFORE THIS INCENTYIVE CONFLICT WOULD ARISE OFTEN IN THE
SERVICE INDUSTRY SUCH AS RESTAURANTS

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MANAGING INCENTIVE CONFLICTS
THROUGH CONTRACTS
The most effective and most efficient way to manage incentive conflicts is by managing solution through costless contracts which are usually incur little to no cost to the firm. The aim of the use of contracts is to arrange the managers utility functions so that profits are maximized while excess
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