Question

An elderly physician has built up his own practice into a quite valuable business. Now that he is thinking of retiring, he wants to take on a partner to learn the business and eventually buy the practice in three years. Her compensation will be a salary plus 25% of the profits if they are below the historical average and 50% for any increase above the historical average. The eventual purchase price for the practice will be 5 times the average profits over the three years. Discuss the efficiency aspects of such a contract. Are the incentives of the buyer and seller aligned?

Answer 1

Overlapping tenure for the retining and new physicians tends to increase the transfer of knowledge. practice specific Pewfit sharing with the new physician increases her incentives to maximize pewfits. However, since the sale price is a multiple of the persfits during this 3 years probation the new physician has an incentive to shink to keep the profits low. It might have been better to use a multiple of profits fawin the period before she began this probation ,