Case – Traveling Salesperson
Question
You are a sales manager at a pharmaceutical manufacturer. You have a sales team that visits doctors to encourage them to prescribe your medicines. You are trying to figure out how to pay your salespeople in order to maximize profits. What are the factors that you would consider in structuring your team’s compensation?
My compensation structure would consist of following aspects:
- basic salary
- performance bonus based on
- number of new doctors who start to prescribe our medicines
- prescription volume of each doctor, decreasing over time
- reason: preventing salespeople and doctors to game the system together. if the medicine is truly useful, the doctors would likely continue using our product without further advertisement.
- territory adjustment: bonus should be adjusted based on how easy it is to promote in a certain area, ensuring a fair performance evaluation across territories.
Case - Insurance
Question
Blue Shield is evaluating whether their new health insurance plan should include a deductible (an amount paid by policy holders for health services, before Blue Shield begins to pay) or coinsurance (a set percentage of the total bill that the policy holders will pay for health services). What are the costs and benefits of issuing a deductible or coinsurance—for Blue Shield, and for policy holders?
- deductible:
- for Blue shield: discourage unnecessary doctor visits, which lowers the cost.
- for policy holders: For healthy policy holder, it is more unlikely that they will benefit from the insurance, but it protects against large medical expenses once the deductible is exceeded
- coinsurance
- for Blue shield: The spending is more predictable, but it has to pay part of every covered claim, which causes higher administrative cost
- for policy holders: If one get severely injured, the discounted bill might still be too high to be affordable, but one don’t feel that the paid money is wasted.
Case – Pharmaceutical Development
Question
The development of pharmaceuticals generally happens in two cycles. First, a biotechnology company produces a new drug. Then, a large pharmaceutical company produces and markets the drug. What are the risks that are controlled by the biotech company? What risks are controlled by the pharmaceutical company? How should these risks influence the structure of a contract to produce, market, and sell new drugs?
Risk of biotech company: investment in the development might not result in a well performing drug. Risk of pharmaceutical company: the new drug may fail commercially because of weak demand, pricing decisions or competitions.
Therefore, the contract should use milestone payments to allocate development risk to the biotech company and commercial risk to the pharmaceutical company. Pharmaceutical company could fund the biotechnology company at each stage of development until the drug reaches the specified performance, and biotechnology could share a part of the marketing profit or loss.
Case – Volcker Rule
Question
Google the Volcker Rule. Think about how what you learnt about contract design can be applied to understanding the rationale of this example of financial regulation.
The Volcker Rule restricts banks from making certain kinds of high risk investments that do not benefit their customers, while benefiting from the government safety net. From the contract design perspective, this financial regulation enforces the “contract” between banks and depositors. It makes sure that the depositors money are kept safe, so that depositors are protected.