Notes - April 11

Notes - April 11 - Problems with Incentive Pay Unintended...

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April 11, 2011 Problems with Incentive Pay Unintended consequences Encourage managers to be short-sighted, and maximize short term value at the cost of long term value Pump up the stock price short term but disregard the long term growth and health of the company Incentive to maximize short term performance; can strongly affect accounting performance by artificially raising the numbers Encourage managers to take too much risk Options have unlimited upside and limited downside risk; you get the benefit without taking too much of the cost This will relate to where the option is at (in-the-money, out-of-the money, etc) May encourage managers to manipulate earnings, commit fraud, manipulate stock prices, etc How to avoid these problems? - Long term incentives - Options with later exercise dates - Executive pensions – defined benefit; firm has to still exist in order to make payments to executives - Value goes down, risk increase Big salary Value of expected future earnings goes down when risk increases
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This note was uploaded on 12/10/2011 for the course FIN 302 taught by Professor Kellybrunarski during the Spring '11 term at Miami University.

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Notes - April 11 - Problems with Incentive Pay Unintended...

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