Lecture12 - 13 - agency moral hazard adverse selection

The companyachievestheseobjectivesthroughapayfor

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Unformatted text preview: un industries – Choose those that pay­off early – Choose those that minimize the manager’s risk, e.g., diversify the firm – Empire building: expand firm size, e.g., through acquisitions Under­leveraging the firm Refusing to pay­out free cash flow 16 Incentive Contracts Shareholders design compensation to induce CEOs to work for the firm and to take actions that maximize share prices These actions include effort, project choice, liquidation, mergers & acquisitions, dividends, capital structure, etc. In general, managers receive a fixed salary, which guarantees them a minimum income, plus additional pay based on performance: bonuses and mostly stock & options. By holding a fraction of the firm’s equity the manager becomes more like an owner. If the manager’s actions increase share prices then his wealth increases, while the opposite happens if his actions decrease share prices. The manager’s compensation contract would look like this: W(V) = w + α * V , where w is a fixed salary, α is the % of shares held by the CEO, and V is...
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