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Answer EACH question in a SEPARATE booklet
SECTION B
Answer ONE question from this section
11. H lmstrom (1979) presents the principal-agent problem in the following way:

Here alpha (α) is the action (or effort) taken by the agent, which is picked from a
set of possible actions (A). The alpha, together with the state of the world/nature
(θ), determines the payoff/output to be shared between the principal and the
agent (x = x(α, θ)). G is the principal’s utility function and H is the agent’s utility
function. G is defined solely by wealth (w), whereas H is defined by both wealth
and action. The principal observes only the output (x). In such cases, the sharing
rule will be a function only of the output. So s(x) is the share that goes to the
agent and r(x) (where r(x) = x – s(x)) is the share of output that goes to the
principal.
Using H lmstrom’s notation, explain how one can achieve a second-best solution
to this basic principal-agent problem. Also, discuss possible extensions to this
model; which assumptions do you have to relax to get these extensions
(35 marks)
12. Describe and analyse the Perceived Cost Approach. Also, evaluate Kevin
Murphy’s attempt to discredit the evidence supporting the Managerial Power
Approach. Has he convinced you Explain your answer.
(35 marks)

SECTION C
Answer ONE question from this section
13. British Petroleum (BP) and Shell compete in the UK oil and gas market. The
following diagram shows a sequential game between BP and Shell in extensive
form. BP has 20% of the UK market share and Shell has 16% market share. BP
and Shell are attempting to determine whether to send geologists to explore Oil
Track 20. The payoffs to each firm from exploration (in billions) are listed in the
diagram.
a) What is the dominant strategy, if any, for Shell
(5 marks)
b) What is the Nash equilibrium or equilibria in this game
(5 marks)
c) What is a first-mover advantage Does BP have a first-mover advantage in this
game
(5 marks)
d) Use the above information to advise BP on whether they should pursue a merger
with Shell.
(5 marks)
e) What are the key managerial insights derived from game theory Which one is
most important in your opinion
(15 marks)
(Total 35 marks)
PTO
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14. Provide comprehensive answers to each of the cases described below.
a) Jim Range owns a Best Ice Cream store, one of 1,000 franchises across the
country. Jim doesn’t like to work evenings, so he hires Mary Smith to work the
store in the evening for ￡6.50 per hour. Mary’s friends come by each evening and
she gives them free ice-cream cones. Is this an adverse selection problem or an
incentive problem What is the solution
(5 marks)
b) John Smith runs Gamemaker, an equipment producer for gaming service
corporations. As CEO, Smith is apparently worth ￡2.5 million per year in the
marketplace. The directors are attempting to decide how to divide his
compensation package between cash salary and perquisites. Using budget
constraints and indifference curves, illustrate the potential outcomes for the Board
of Directors.
(10 marks)
c) Player A moves first and can go L, M or R. Player B moves second and can go R,
M or L. If both of them end up at L or at R, A gets ￡1 and B gets ￡0. If one ends
up at L and the other at R, then B gets ￡1 and A gets ￡0. If B ends up at M while
A does not, then A gets ￡1 while B gets ￡2. If both of them end up at M then both
get ￡0. Show that A has no first-mover advantage in this game.
(10 marks)
d) Players C and D are going to play a game twice. During both repetitions, if they
both select a low price or a high price, their market share stays the same. But if
one selects a low price while the other selects a high price, then the one with the
low price gets more market share while the one with the high price loses some
market share. Based on this information what is the most likely outcome in both
periods
(10 marks)
(Total 35 marks)
END OF EXAMINATION PAPER
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