FAT Week 8 - FAT Week 8 Executive Compensation Agency...

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FAT Week 8 Executive Compensation Agency problems -> need incentives -> C.C. C.C -> 1. Types (fixed-pay, perf based – bonus, stock options) => Adv & disadv of acc-based measures => How to measure efforts? 2. Political process (C.C. & CEO) Types of C.C 1. Fixed Pay Typically pays managers a fixed salary, irrespective of output Adv for s/h: X incentive for managers to manipulate f.s. & perf to their benefit & potentially to cost of s/h Disadv for s/h: X incentive for managers to take risks & max returns for s/h 2. Perf-based Reward managers based on pre-set perf targets Good performance – High pay; Bad perf – Low pay E.g. Target earnings levels, share price Measuring managers’ performance (effort) Difficult to measure (High effort X necessarily lead to +ve perf outcomes, low effort sometimes produce +ve outcomes) Choose outcome-based indicators of manager’s effort = F.s. o Assumption: Strong financial perf due to manager making significant effort o Commonly used indicators: profitability measures, share price Fully efficient labour market? Surely if a manager X work hard, will be fired & reflected on resume (If expected costs of lost reputation large enough & can be accurately reported, then no need incentive contracts) Adverse selection & moral hazard exist! (Managers can cover up shirking, at least in ST by manipulating E) *Thus, need incentive contracts
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Attributes of Good PM Highly informative about manager effort : SR & LR How informative of PM depends on: (i) Sensitivity (FV) -
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Christopher Reinemann
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