A good salesperson can sell $1,000,000 worth of goods, while a poor one can sell only $100,000 worth of goods. Job applicants know if they are good or bad, but the firm does not

Question

A firm will offer job applicants a choice between a fixed salary of $25,000 or 20% commission. Assuming risk-neutral salespersons and the possibility of opportunistic behavior, will this choice of contracts allow the firm to distinguish between good salespersons and bad ones before the hiring decision is made?

Answer 1

Under commission, a good salesperson will earn $200,000 and a poor salesperson will earn $20,000. A fixed salary that is above $20,000 but less than $200,000 would be preferred only by poor salespersons. The $25,000 will work at screening out poor salespersons as long as the income that bad salespersons could earn elsewhere is at least $20,000, but less than $25,000. If the poor salesperson's opportunity cost of working for this firm is less than $20,000, he might accept the commission plan just to send the false signal that he is a good salesperson, and, therefore, be hired.