Question: Agency Theory The Tamura International Trading Company plans to hire a manager for its division in Mexico City. Tamura International's president and vice president of personnel are trying to decide on an appropriate incentive employment contract. The manager will operate far from the Tokyo corporate headquarters, so evaluation by personal observation will be limited. The president insists that a large incentive to produce profits is necessary; he favors a salary of ¥150,000 and a bonus of 10% of the profits above ¥1,200,000. If operations proceed as expected, profits will be ¥4,600,000, and the manager will receive ¥490,000. But both profits and compensation might be more or less than planned. The vice president of personnel responds that ¥490,000 is more than most of Tamura International's division managers make. She is sure that the company can hire a competent manager for a guaranteed salary of ¥400,000. She argued, "Why pay ¥490,000 when we can probably hire the same person for ¥400,000?"
1. What factors would affect Tamura International's choice of employment contract? Include a discussion of the pros and cons of each proposed contract.
2. Why is the expected compensation more with the bonus plan than with the straight salary?