Question

The following excerpt is from a paper called "Current Global Financial Crisis: An Incentive Problem" by Pascual Beronee; IESE Business School - University of Navarra, Barcelona Spain.

This article discusses the global financial crisis as a consequence of common (although inadequate) corporate governance practices. More specifically, it indicates that stock options lead to excessive risk taking, like subprime mortgage securities, because they have no penalty for the manager nor damage to her/his wealth in the case of collapse. "In tandem, golden parachutes and other exit packages incite termination of the employment contract since they reward failure, providing little incentive for the executive to perform adequately...."

"One of the problems of stock options and similar instruments is that executives rewarded with stock options benefit when the stock price rises but experience no reduction in real wealth if the stock price declines. Managers may respond to these instruments with excessive risk-taking actions since they would not see their wealth damaged in the ease of stock price drops. This is probably the main reason why companies like Lehman Brothers, Fannie Mae or Freddie Mac got involved in very risky ventures like mortgage securities."

Required

In terms of Management Control Systems and Agency Theory, discuss how these types of compensation schemes might cause managers to deviate from the stewardship role that is delegated to them by the shareholders. Also, explain how than are corporations through management able to fulfill the organizations' strategy.

Answer 1

When the employees are given stock options and the like, this would actually not induce them in any manner and it is widely seen that all these managers tend to take high end risks which majority times go badly or wrong and result in a huge loss. But at the same time, when these risks take go well, they would opt for the stock options given to them and then sell the same and reap their benefits. In my opinion this happens mainly because, mere stock options provided as incentives will not have the power to induce the employees to put in more efforts and take up projects with high rate for success. And when they are given the right to the stock of the company they actually shift from being a steward and serving the company to the genre of being owners or the shareholders themselves. This is one major reason why they shift from their stewardship role and take up those heavy rated risks which mostly would go bad.

Corporation can attain their strategy through the management only when they are induced with the proper compensation and incentive plans rather than mere stock options given to them. To get the work done and the strategy achieved they should see the gift or the compensation or the recognition that is waiting for him or her at the attainment of the end result. So, I would always recommend that these inducement plans should be a perfect mixture of award or recognition, stock options and a monetary compensation as this would only help the manager’s move forward by taking healthy risks for both the company and him or her as the manager.