14.1 Economic settings in which one side has better information than the other. Buying a Company Firm T is worth $20 a share or $80 (50-50 chances) depending on the outcome of a patent dispute. If acquired by Firm A, synergies are worth an additional $20 per share. What tender offer is best for firm A? Asymmetric information leads to adverse selection and prevents mutually beneficial transactions. ASYMMETRIC INFORMATION

14.2 Adverse Selection occurs when the agent (whose interests are at odds with the principal’s), holds unobservable or hidden information. A Building Contract Moral Hazard occurs when the agent (whose interests are at odds with the principal’s), takes unobservable or hidden actions. Bidding for Baseball Free Agents Bidding for an Oil Lease PRINCIPLE-AGENT PROBLEMS

In House or Out Sourcing 2. Centralized or Decentralized 3. Providing the Right Incentives Three Important Issues Firms are organized to minimize the total cost of production, including transaction costs. ORGANIZATION DESIGN

14.4 Effort Level Gross Profit Disutility Net Profit Super $90 k -$60 k $30 k High $85 k -$45 k $40 k Medium $75 k -$39 k $36 k Low $60 k -$35 k $25 k The worker chooses low effort if paid a flat wage. The worker will rationally expend extra effort only if better profit results mean she receives bonus pay. What profit-share fraction is needed to induce optimal effort from the worker? INCENTIVE PAY