Question

“It is important to align shareholders’ incentives with those of the managers. Otherwise, the managers will not work hard and they will not take risks. To do this, managers must be given lots of call options. The more call options managers get, the greater will be the alignment of their incentives with those of shareholders. Moreover, to increase the incentive effects, the call options must be non-tradable, they must be in the money (exercise price must be less than the stock price at the time of the award), and they must have long time to maturity (like 10 years).”

Answer 1

Managers are given lots of call options--ie. The right but not any obligation to buy the company's stocks at a specified price called the exercise price or strike price ,within a specified time-period-- a chance to become owners of the company in appreciation of their efficiency at work.

The options are said to in the money when that exercise price is less than the stock price --as the option holder can buy the stock from the company & sell in the market at the ruling/prevailing price in the market & thus can make some profit .

Lots of such call options encourage the managers to take more pronounced risks such as large capital investments, more business acquisitions or higher capital outlay in research projects.

Aligning the interests of the people managing a compnay with the interests of its shareholders is resorted to by many companies,so that they concentrate wholly in the business' development & not in their own interest .

The call options offered to the managers must have long time to maturity (like 10 years) ,so that they will strive for increasing the market price of the company's stock as much as possible ,so that they gain more ,when they exercise their option & also have adequate time to study the market--- & be with the company till then.