Question

1. Under what circumstances should a firm apply strong incentives to a performance measure and when would it make sense to apply a weak or no incentive to a performance measure? Please give an example of each.

Answer 1

Weak incentive:

If a firm is very large (like a C Corporation that has shares in the market and registered in SEC) the top management (like CEO) should have weak incentives for their performances. This is so because they are discouraged with wrong, unlawful, or unethical performances. If there is strong incentive (higher amount of commission) for higher value of market share price, this could be misused by the CEO by a wrongful attempt (manipulation) to increase the market share price. In order to stop it there should be weak or no incentives for them

Strong incentive:

If the same firm doesn’t have shares in the market, it becomes small. In that case the CEO should get strong incentive in order to make the firm big – like an increasing growth in production or revenue. CEO or management of a small firm usually get lower payments. Therefore, it becomes necessary to encourage them to do better and for that purpose a strong incentive is required for them,