The DuPont case is a good example of an incentive package gone awry. In review, it placed a portion of employee's pay into an "at-risk pool." If the division had exceeded expectations, the employees would have received a bonus from the pool. How would a "relative performance contract" have saved the DuPont bonus system?
What will be an ideal response?
DuPont could have benchmarked its division's profits against performance by other firms in other relevant markets. However, there are several relevant markets, e.g. housing, automobiles, apparel. It would be tricky to assign weights to those markets. Another option would have been to judge the division relative to other DuPont divisions. Poor overall economic performance would also affect some other divisions. The problem with this plan is that some divisions would be harder hit than others, depending on which sectors were hit hardest by the recession and by high input prices. The advantage is that the employees might not have faced significant financial losses.
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An externality refers to the idea that
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Cassie's Quilts alters, reconstructs, and restores heirloom quilts. Cassie has just spent $800 purchasing, cleaning, and reconstructing an antique quilt which she expects to sell for $1,500 once she is finished. After having spent $800, Cassie discovers
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