In 2009, Detroit, Michigan experienced an aggressive recession as compared to the rest of country. With unemployment rates topping 15%, the city was faced with many challenges financially, economically, and socially. In addition to the financial challenges, the city was also experiencing political instability and corruption. Various major city officials were being investigated for fraud, bribery, and other criminal charges. Spirit Electric, operating as a natural monopoly, was the only company in the area providing electric services to Detroit households. Like many other companies, it was experiencing financial difficulties and could no longer continue without some intervention. This was mainly due to high operating costs, foreclosures in the area, and the fact that many households were not paying their bills. As a result, Spirit Electric came to a standstill in the latter part of 2009. Matt Green, Spirit Electric CEO, gathered the Board of Directors and determined that the company would need to take some sort of action in order to remain in business. CEO Green outlined four proposals and urged each board member to vote accordingly, providing justification for their chosen proposal. The following are the four proposals made by CEO Green: Proposal 1 Ask the government for a bailout of $30 million in order to allow Spirit Electric to continue operation. Payback will be at 15% within 5 years. Proposal 2 Allow two outside electric companies to join the industry and supply electric to the people of Detroit. These companies would be competing against one another, and households would have a choice as to which electric company they would purchase services from. Proposal 3 Increase electric rates in the short term for all users. Once the economy rebounds, electric rates will return to normal. Proposal 4 Create private, “virtual” accounts managed by Spirit Electric for all households. These accounts would allow households who fall behind on their payments to “credit” their account with a 2% fee after 6 months of not making payments. In choosing Proposal 1, Did a principal agent problem occur in this situation? How can it be avoided moving forward?

In 2009, Detroit, Michigan experienced an aggressive recession as compared to the rest of country. With unemployment rates topping 15%, the city was faced with many challenges financially, economically, and socially. In addition to the financial challenges, the city was also experiencing political instability and corruption. Various major city officials were being investigated for fraud, bribery, and other criminal charges. Spirit Electric, operating as a natural monopoly, was the only company in the area providing electric services to Detroit households. Like many other companies, it was experiencing financial difficulties and could no longer continue without some intervention. This was mainly due to high operating costs, foreclosures in the area, and the fact that many households were not paying their bills. As a result, Spirit Electric came to a standstill in the latter part of 2009. Matt Green, Spirit Electric CEO, gathered the Board of Directors and determined that the company would need to take some sort of action in order to remain in business. CEO Green outlined four proposals and urged each board member to vote accordingly, providing justification for their chosen proposal. The following are the four proposals made by CEO Green: Proposal 1 Ask the government for a bailout of $30 million in order to allow Spirit Electric to continue operation. Payback will be at 15% within 5 years. Proposal 2 Allow two outside electric companies to join the industry and supply electric to the people of Detroit. These companies would be competing against one another, and households would have a choice as to which electric company they would purchase services from. Proposal 3 Increase electric rates in the short term for all users. Once the economy rebounds, electric rates will return to normal. Proposal 4 Create private, “virtual” accounts managed by Spirit Electric for all households. These accounts would allow households who fall behind on their payments to “credit” their account with a 2% fee after 6 months of not making payments. In choosing Proposal 1, Did a principal agent problem occur in this situation? How can it be avoided moving forward?

Managerial Economics: A Problem Solving Approach

5th Edition

ISBN:9781337106665

Author:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Publisher:Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor

Chapter9: Market Structure And Long-run Equilibrium

Section: Chapter Questions

Problem 9.6IP

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Question

In addition to the financial challenges, the city was also experiencing political instability and corruption. Various major city officials were being investigated for fraud, bribery, and other criminal charges.

Spirit Electric, operating as a natural monopoly, was the only company in the area providing electric services to Detroit households. Like many other companies, it was experiencing financial difficulties and could no longer continue without some intervention. This was mainly due to high operating costs, foreclosures in the area, and the fact that many households were not paying their bills.

As a result, Spirit Electric came to a standstill in the latter part of 2009. Matt Green, Spirit Electric CEO, gathered the Board of Directors and determined that the company would need to take some sort of action in order to remain in business.

CEO Green outlined four proposals and urged each board member to vote accordingly, providing justification for their chosen proposal.

The following are the four proposals made by CEO Green:

Proposal 1	Ask the government for a bailout of $30 million in order to allow Spirit Electric to continue operation. Payback will be at 15% within 5 years.
Proposal 2	Allow two outside electric companies to join the industry and supply electric to the people of Detroit. These companies would be competing against one another, and households would have a choice as to which electric company they would purchase services from.
Proposal 3	Increase electric rates in the short term for all users. Once the economy rebounds, electric rates will return to normal.
Proposal 4	Create private, “virtual” accounts managed by Spirit Electric for all households. These accounts would allow households who fall behind on their payments to “credit” their account with a 2% fee after 6 months of not making payments.