CFA Level I · CFA Level I Exam · Investors and Other Stakeholders
A board considers compensation for a CEO whose firm has significant debt. Which design is most likely to reduce both the shareholder-manager conflict and the shareholder-creditor conflict?
The best design is long-term compensation mixing equity and debt-like deferred pay with clawback. It aligns the manager with both shareholders and creditors and discourages short-termism and excessive risk. Revenue-based bonuses or immediately vesting options reward growth or risk regardless of value, worsening conflicts.
- ABonuses based entirely on annual revenue growth
- BStock options as the dominant pay component, vesting immediately
- CLong-term pay with a mix of equity and debt-like deferred compensation, subject to clawbackCorrect
Explanation
Deferred pay combining equity and debt-like elements aligns the manager with both shareholders and creditors, discouraging excessive risk, and long horizons with clawbacks limit short-termism. Revenue bonuses reward growth regardless of value, and option-heavy immediate vesting encourages risk-taking that harms creditors.
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