Eco 550 Assignment 1

CHAPTER 1 QUESTIONS:

#2. Explain several dimensions of the shareholder-principal conflict with manager agents known as the principal-agent problem.

~Whenever one pursues acts in the best interest of another, there is bound to be some conflict. Principal agent problems are incentive conflicts that arise while delegating decision making authority. Some things that may arise when making decisions on behalf of shareholders are: deciding which shareholder(s) to satisfy to keep profitable corporations but while also remaining ethical. Another area that presents a conflict is when the manager acts on behalf of shareholders but to ultimately increase their own self interests. This would also ultimately limit risk taking which can prove to have an unfavorable outcome. Due to this, many shareholders require some agents to obtain stock in the company to align the pocketbook interest of managers with those of stockholders.

To mitigate agency problems between senior executives and shareholders, should the compensation committee of the board devote more too executive salary and bonus (cash compensation) or more to long-term incentives?

~Long-term incentives should be the focus because this has proven to be the most effective way of rewarding all of those whom aided and or contributed to the company’s overall growth.

What role does each type of pay play in motivating managers?

Compensation is a way for a company’s leadership to communicate where the company’s vision is going and how they plan to strategically get there. Long-term incentives help encourage appropriate behaviors with intention to drive the results needed to be transformed to promote growth for the company. Long-term incentives are also considered to be one of the most effective reward systems because it tends to promote more equality amongst all managers and or employees. While cash compensation has the benefits as above, especially encouragement towards driving for results, but it also offers more...