Question

BK Books is an online book retailer that also has 10,000 “bricks and mortar” outlets worldwide. You are a risk-neutral manager within the Corporate Finance Division and are in dire need of a new financial analyst. You only interview students from the top MBA programs in your area. Thanks to your screening mechanisms and contacts, the students you interview ultimately differ only with respect to the wage that they are willing to accept. About $\mathbf{10}$ percent of acceptable candidates are willing to accept a salary of $\mathbf{\text{(70,000}}$, while$\mathbf{90}$ percent demand a salary of$\mathbf{\text{)100,000}}$ . There are two phases to the interview process that every interviewee must go through. Phase$\mathbf{1}$ is the initial one-hour on-campus interview. All candidates interviewed in Phase $\mathbf{1}$are also invited to Phase$\mathbf{2}$ of the interview, which consists of a five-hour officevisit. In all, you spend six hours interviewing each candidate and value this time at$\mathbf{\text{(900}}$ . In addition, it costs a total of $\mathbf{\text{)4,900}}$in travel expenses to interview each candidate. You are very impressed with the first interviewee completing both phases of BK Books interviewing process, and she has indicated that her reservation salary is$\mathbf{\text{\$100,000}}$ . Should you make her an offer at that salary or continue the interviewing process? Explain.

Short answer

The offer should be made at the salary.

Step-by-step solution

Asymmetric Information 

The existence of incomplete information in a market due to which the market cannot function properly is called asymmetric information. This can be present from the side of the buyer or the sellers, but the ultimate thing is that the market allocation fails in providing efficiency and oneparty ends up paying more than the others.

Evaluating the cost 

Assuming that the BK books manager is risk averse, the new financial analyst he is trying to employ will not be paid a salary between$\text{\$70,000}$and$\text{\$100,000}$,$\text{10\%}$of the candidates are ready to take a salary of$\text{\$70,000}$and the remaining$\text{90\%}$a salary of$\text{\$100,000}$.

The estimated benefit of an additional candidate is searched by using the formula below. In this scenario, we are choosing the lowest likelihood, assuming that$\text{10\%}$of people are prepared to take a$\text{\$70,000}$pay.

Thus,

$\begin{array}{c}E\left(b\right)=10\%\times (w_1-w_2)\\ =0.10\times (100,000-\$70,000)\\ =0.10\times 30,000\\ =3,000\end{array}$

This is the amount that the corporation will set aside for each candidate who declines an interview, i.e., $3000.

The overall cost for the company may be calculated by adding the two phases of the interview conducted by the firm:

Phase one costs$\text{\$900}$.

Phase two costs $\text{\$4,900}$.

Overall Cost

As a result of the above scenarios, the overall cost may be calculated as follows:

$\begin{array}{c}C\left(x\right)=\$900+\$4,900\\ =\$5,800\end{array}$

As a result, the cost of conducting another interview to find another candidate, assuming the inherent costs of each phase, will be much higher than hiring the first interviewee. So, hiring the first interviewee will be in the manager's best interest.

Therefore, making an offer at salary is the best option.