Chapter 1: Problem 2.
Explain several dimensions of the shareholder-principal conflict with manager agents known as the principal-agent problem. To mitigate agency problems between senior executives and shareholders, should the compensation committee of the board devote more to executive salary and bonus (cash compensation) or more to long-term incentives? Why? What role does each type of pay play in motivating managers? The compensation committee should devote more to long-term incentives for the following reason. The goal of every organization is to retain employees. I’ve found in my career that employee retention is successful when employees have a good long-term incentive package. For instance, I work for a company who gives stock options to managers/employees however employees are not able to cash out the monies for 3 years. These options were evaluated each year and the grant price continued to increase. At the end of the three years, employees could either cash out the stock grant or hold onto them for a total of 10 years. Many managers cashed out well over $40K every three years and while still receiving their salary and bonus each year. Salaries and bonus’ are key in motivating managers initially, however most manager are looking for something extra in terms of recognition. Long-term incentives like stock options or even options to receive cash rewards throughout the year are great motivators and give managers something to look forward to.
Chapter 1: Problem 3.
Corporate profitability declined by 20 percent from 2008 to 2009. What performance percentage would you use to trigger executive bonuses for that year? Why? What issues would arise with hiring and retaining the best managers? When profitability declines, companies should base their bonuses on the company’s revenue performance. This policy should be announced at the beginning of the year or when managers receive their performance guidelines. Instating this behavior makes executive...
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