Recently, the owner of KFC Franchise decided to change how she compensated her top manager. Last year, the manager received a fixed salary of GHC50,000 and KFC made GHC110,000 in profits (excluding the manager's compensation). She feared that her store’s performance was connected to the top manager shirking on the job and expected that changes to her top manager's compensation structure would improve sales. Therefore, this year she decided to offer him a fixed salary of $40,000 plus 5 percent of the store's profit. Since the change, the store is performing much better, and she forecasts profits this year to be $300,000 (again, excluding the manager's compensation). Assuming the change of compensation is the reason for

The increased profits, and the forecast is accurate, how much more money will the owner make (net of payment to her top manager) because of this change? Does the manager make more money under the new payment scheme?

Ans:

Previous Scheme:
Owner makes:110,000
Manager Compensation: 50,000
New Scheme:
Manager Compensation: 40,000 + (5%*300,000)
= 40,000+15,000
= 55,000
Owner makes:300,000 - (5%*300,000)
= 300,000- 15,000
=285,000
Hence, both manager and owner make more money under the new payment system.
Employees paid a flat salary have little incentive to work harder for their employer because their pay won't increase as a result. There is little point working harder when you are not getting paid for it. Giving employees a share of profit means that their pay goes up along with employer's profit. Thus, profit sharing schemes potentially enduce employees work harder. As a result, the owners see profit increase.