Cyu Week 1

E.Austin

Check Your Understanding

Chapter 1

2. Explain several dimensions of the shareholder-principal conflict with manager-agents known as the principal-agent problems. To mitigate ageny 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?

As businesses grow into limited liabilites corporations, the owners(the principals) frequently delegate decision-making authority to professional managers(the agents). Being that the manager-agents have much less to lose than the owner-principals, the agents often seek acceptable levels of profit and shareholder wealth while pursuing their own self-interests. Pursuing their own self-interests can also lead managers to focus on their own long-term job security. This can motivate them to limit the amount of risk taken by the firm because an unfavorable outcome resluting from the risk could lead to their dismissal. Some companies structure a larger proportion of the manager's compensation in the form of performance-based payments. Others require senior managers and directors to own a substantial amount of company stock as a condition of employment. The idea behind this is to align the pocketbook interests of managers directly with those of stockholders. A problem that can arise is knowing when to reward managers for upturns and when to blame them for poor performances. By giving the managers ownership of stocks allows managers to pursue goals, such as maximization of their own personal welfare, that are not always in the long-term interests of shareholders. Due to this, a growing number of coporations are seeking to assure that a larger proportion of manager's pay occurs in the form of perfomance-based bonues. This is done by tying executive bonuses to the performance of comparably situated competitor...