Chapter 1: Problem 2.
Explain several dimensions of the shareholder-principal conflict with manager agents known as the principal-agent problem. To mitigate agency problems between senior executives and shareholders, should the compensation committee of the board devote more to executive salary and bonus (cash compensation) or more to long-term incentives? Why? What role does each type of pay play in motivating managers? The compensation committee should devote more to long-term incentives for the following reason. The goal of every organization is to retain employees. I’ve found in my career that employee retention is successful when employees have a good long-term incentive package.
For instance, I work for a company who gives stock options to managers/employees however employees are not able to cash out the monies for 3 years. These options were evaluated each year and the grant price continued to increase. At the end of the three years, employees could either cash out the stock grant or hold onto them for a total of 10 years. Many managers cashed out well over $40K every three years and while still receiving their salary and bonus each year. Salaries and bonus’ are key in motivating managers initially, however most manager are looking for something extra in terms of recognition. Long-term incentives like stock options or even options to receive cash rewards throughout the year are great motivators and give managers something to look forward to.
Chapter 1: Problem 3.
Corporate profitability declined by 20 percent from 2008 to 2009. What performance percentage would you use to trigger executive bonuses for that year? Why? What issues would arise with hiring and retaining the best managers? When profitability declines, companies should base their bonuses on the company’s revenue performance. This policy should be announced at the beginning of the year or when managers receive their performance guidelines. Instating this behavior makes executive managers develop business strategies that will move the business forward.
Chapter 1: Problem 6.
In the context of the shareholder wealth-maximization model of a firm, what is the expected impact of each of the following events on the value of the firm? Explain why. a. New foreign competitors enter the market.
When a new foreign competitor enters the market, companies need to strategize to develop new ways to compete in the market place so that they do not lose customers. b. Strict pollution control requirements are enacted.
c. A previously nonunion workforce votes to unionize.
When a company unionizes, and salaries and benefits are renegotiated; it could cause a company to either increase costs or cut the employee salaries.
d. The rate of inflation increases substantially.
When the rate of inflation increases, companies need to look at their future profits and decide how much of the inflation costs they will pass onto their customers and how much they will take on themselves. If they make the right decision and slowly pass onto customers the hiked prices they will continue to be profitable however if they increase prices substantially, they could lose customers.
e. A major technological breakthrough is achieved by the firm, reducing its costs of production. This is great news for a company. It provides a more efficient way of doing business for half the cost. This could be the beginning of initiating long-term incentives for a company.