Question

Explain two or more motivational tools that can aid in aligning stockholder and management interests

Answer 1

The useful motivational tools that will aid in aligning stockholders’ and management’s interests include:

(1) Reasonable compensation packages:

The first important thing is the monetary benefit. The compensation package should be sufficient to attract and retain able managers but not go beyond what is needed. Also, compensation packages should be structured so that managers are rewarded on the basis of the stock’s performance over the long run, not the stock’s price on an option exercise date. This means that options should be phased in over a number of years so managers will have an incentive to keep the stock price high over time. Since intrinsic value is not observable, compensation must be based on the stock’s market price but the price used should be an average over time rather than on a specific date. This will motivate the managers and also stop unnecessary price fluctuations.

(2) Direct intervention by stockholders, including firing managers who don’t perform well:

Stockholders can intervene directly with managers. Today, the majority of stock is owned by institutional investors and these institutional money managers have to exercise considerable influence over firms’ operations. First, they can talk with managers and make suggestions about how the business should be run. In effect, these institutional investors act as lobbyists for the body of stockholders. Second, any shareholder who has owned $2,000 of a company’s stock for one year can sponsor a proposal that must be voted on at the annual stockholders’ meeting, even if management opposes the proposal. Although shareholder-sponsored proposals are non-binding, the results of such votes are clearly heard by top management.

(3) The threat of takeover:

If a firm’s stock is undervalued, then corporate raiders will see it to be a bargain and will attempt to capture the firm in a hostile takeover. If the raid is successful, the target’s executives will almost certainly be fired. This situation gives managers a strong incentive to take actions to maximize their stock’s price.