Question

24. What is the theory behind giving management stock options? What are the agency risks.

Answer 1

The theory behind management stock options is that the management should have a stake in the company. This will encourage them to work towards the wealth maximization goal rather than think about their personal gain only in the form of compensation from the company. if the managers have stock options they will be interested in increasing the share value. This will push them towards working towards the final goal of financial management.

This also reduces the agency risk which is the Probability of loss due to an agent's focus on his or her own interests instead of those of the principal.