There have been several problems associated with management compensation at publicly traded companies being uncorrelated with...

There have been several problems associated with management compensation at publicly traded companies being uncorrelated with management performance. Which of the following proposals on compensation offers the most promise in dealing with this problem?

a. Put a cap on management compensation at all companies; annual compensation for a manager cannot exceed $ 5 million.

b. Require that all top management compensation contracts be put to shareholder vote (rather than be approved by the board of directors)

c. Ban all “equity” based compensation (options, restricted stock etc.)

d. Require that at least 50% of compensation be in the form of equity options. e. Require that compensation be explicitly tied to current profits

please explain why thank u

Expert Solution

We will analyze the impact of management performance and management compensation for all the four options one by one :-

a) Put a cap on management compensation at all companies; annual compensation for a manager cannot exceed $ 5 million.

If we put a cap on management compensation, then management will not have an incentive to work for the improvement of the company year on year, they will feel frustrated that even if the company improves in terms of profitability, they will not get anything more than $5 million. So this is not the correct way

b) Require that all top management compensation contracts be put to shareholder vote (rather than be approved by the board of directors)

Most of the companies and stock exchanges around the world have this option of putting the management compensation contracts to vote, so that shareholders have right to decide the amount of compensation company management should enjoy.

c) Ban all “equity” based compensation (options, restricted stock etc.)

Banning of all the equity based compensations will have detrimental effects on the management, they will not have incentive to participate in the improvement of company profitability , which in terms improves the stock price of a firm.

d) Require that at least 50% of compensation be in the form of equity options.

Giving compensation of at least 50% in the form of equity shares or options is also not feasible or good options because ,management need some static amount of compensations so that it can actively manage the operations of the company ,since company share may take time to grow even if the profitability grows and both does not grow in tandem.

e) Require that compensation be explicitly tied to current profits.

This will be detrimental to start up companies management, because start up companies profit during the initial year is very less or it is negative sometimes.

So the best way to go around is give some static amount of compensation along with 10-20% of equity options and put the proposal to shareholder voting before confirming the contracts of the management or boards.

Rahul Sunny answered 1 year ago

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