Question

3. What incentive conflicts exist in corporations? What mechanisms are used to address the

incentive conflicts in corporations?

Answer 1

Much of the stock of large publicly traded corporations is held by diversified investors who take little interest in the governance of individual firms. Operational control of large corporations is delegated to professional managers and overseen by a board of directors who have limited financial interests in the firm. There is separation of ownership and control. This separation implies that corporate decision makers have weaker incentives to use assets productively than in small businesses where ownership and control are held by the same person. There are also incentive conflicts among other stakeholders of the firms like between shareholders and bondholders.

There are internal mechanisms that are used to address the incentive conflicts in corporations are : (1)Board of directors,(2) Internal auditing , (3) Incentive compensation schemes.