Question

(a) In compensating a senior executive like the CEO of a firm, is there a difference between giving them stock options as opposed to a bonus based on achieving a specific profit level or achieving a specific stock price?

(b) Is either option a more effective incentive in solving the owner-manager principal-agent problem. Please explain.

(c) Why do many firms choose to give their CEOs stock options rather than bonuses? Please explain.

Answer 1

A)

Yes. In compensating senior executives, there is a difference between giving them stock options as opposed to a bonus based on achieving a specific profit level or achieving a specific stock price. This is because these options work differently on employee motivation and thus bring out different results for the company in the form of profits and for the employee in the form of bonus

B)

Yes, the stock option is a more effective incentive in solving the owner-manager principal-agent problem as it incentivizes the employee to make sure the company is performing well not only on the inside but also on the inside. The stock option as bonus will incentivize him to increase the company’s profits, net worth and thus stock values, thereby benefitting both the company as well as the employee.

c)

This is because the stock options would motivate the employee to make sure the company is making enough profits so as to increase his compensation amount. This will benefit the company as the employees will put in extra hard work to increase the company’s stock value and thus their own compensation amounts.