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Question 2. Explain why the structure of executive compensation contracts should minimise agency costs and how...

Question 2.
Explain why the structure of executive compensation contracts should minimise
agency costs and how information asymmetries can lead to moral hazard and hidden actions.

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Answer #1

Executive compensation contract is different from other compensation contracts. In this form of compensation contract the executives pay is heavily based on the actual results. If a company underperforms, then the executives typically receive a smaller amount of their potential pay. Conversely, if the stock overperforms then the executives receive larger payout. This helps to reduce agency problem as the executives are not overpaid. This keeps the shareholders calm and not get agitated, and eventually reduces agency problem.

Asymmetric information means uneven information being provided to different people. This asymmetric information makes the managers do insider trading and also to be dishonest with their profession and the clients. This leads to moral hazard and some unwanted actions in order to make more money.

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