Better yet base pay on what executive has control over shelter them from those

Better yet base pay on what executive has control

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Better yet, base pay on what executive has control over, shelter them from those over which they have little (ex. rewards according to the firm’s shares relative to others in same industry)
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Summary of 15.3: - Optimal-contracting view: design executive pay to align interests of managers with interest of owners - assume managers and shareholders negotiate at arm’s length over pay - Managerial power view: rent extraction - Managers influence board members who set their pay; succeed in skimming rent (incomes in excess of what market efficiency and maximum shareholder value would dictate) from the people who employ them Summary of 15.16: - Options granted to top executives just before stock jumped; companies had to be backdating options - direct transfer of wealth from stockholders to insiders - Focus on mispriced securities that have a relationship to each other - Company that fails to file financial documents on time (usually because of accounting error) has bonds in default -> Buy bonds “below par” -> tell company since it was in default, it is liable for full face amount - Backdating options -> companies will have to restate financials for years during which they were backtracking meaning they will not be able to file their annual report on time -> bondholders can squeeze them by shorting 1. Why might managers care about the market value of their companies’ stocks even if they had no equity stake themselves? - Hard to monitor success of managers - easiest way is to look at market value - Shareholders are owners; bosses can lose jobs - In the 1980s, board of directors began linking bonuses to long-term value of company The stock value is a measure of how the public thinks the company is doing. Price discovery in the market evaluates investments, business strategies, and management competence, and provides signaling about what the market considers to be the consequences of actions. As managers are also beholden to shareholders and boards, they will aim to please. - Reputation as managers will be harmed - Have a career path - Could be acquired 2. Why are stock options a better incentive device for managers than outright ownership of stock? - Allow executives to reap rewards of boosting share price while sheltering them from failure - With too many outright shares, manager could become risk averse and avoid making investments that could be successful (be overly conservative) - Issues still exist: rewarding mediocrity, prices reset when company’s shares fall, managers can cash out options as soon as they are vested
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- Stock options are better because stock is illiquid and not diverse, so would incentivize conservative investments at the cost of profits or reliance on derivatives to hedge risks that should be left alone. - Options give the right to buy shares at a preset price, so are a source of profit if share prices rise but provide protection if prices fall.
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