AMaheshwari_BUS540-LH_Module05_05-05-2011

AMaheshwari_BUS540-LH_Module05_05-05-2011 - Module51...

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Module 5      1 Module 5
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Module 5      2 Abstract Response to the first question discusses the trade-offs between efficient risk bearing  and   incentives   in   compensation   plans   such   as   Incentive   compensation   exposes  employees to risk that are borne at lower cost by diversified investors. Response to the  second question lists factors favoring high incentive pay such as, the sensitivity of the  value of output to additional effort by the employee is higher, the employee is less risk- averse, the level of risk that is beyond the employee's control is lower, the employee  response   to   increased   incentives   in   terms   of   exerting   additional   effort   is   more  pronounced, and employee output is more easily measured. Response to third question  focuses on Cost-benefit analysis of 360 degree Performance Evaluation system. 360- degree evaluation system, or multi-rater feedback, was used by 90% of Fortune 500  companies  last  year.  It   is  generally  believed  to be  a  highly  effective performance  evaluation tool. Organizations that experience success with the 360-degree feedback  methods have many environmental attributes present. Response to the fourth question  discusses the fact that CEO’s in US are paid highly relative to rank- and file employees.                               .
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Module 5      3 Module 5 Deliverables Assignments:  Questions Question:   1. Discuss trade-offs between efficient risk bearing and incentives in  compensation plans. Response :  The magnitude of the agency problem in terms of the degree of separation  between   the   interests   of   owners   and   managers,   suggest   that   linking   manager's  compensation too closely to firm performance might lead to risk-avoiding behavior on  the   part   of   the   manager.   This   argument,   stresses   the   fact   that   while   contingent  compensation may seem to have desirable incentive and motivational properties relative  to no contingent forms of compensation, it also has undesirable risk-bearing properties  such as compensation contract would cause a manager to bear risk that could be more  efficiently borne by diversified stockholders. The underlying assumption is that the  manager, unlike the owners, has already invested most of his or her non diversifiable  and non tradable human capital in the firm and that the agent is relatively risk averse,  while the principal is relatively risk neutral. It follows that agents would be reluctant to  bear this risk of firm performance and that it is therefore difficult and costly for the  principal to have the agent bear this risk. 
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AMaheshwari_BUS540-LH_Module05_05-05-2011 - Module51...

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