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CMA Intermediate · Financial Management and Business Data Analytics · Introduction to Financial Management

A firm's managers have a stock option plan under which they receive shares if the share price rises above a set level over three years. The main purpose of this plan in reducing agency problems is to:

The plan aims to link managers' rewards to shareholder wealth, so managers benefit only when the share price rises. This aligns the interests of agents with principals and reduces the agency problem, though it does not remove the need for monitoring such as audit.

  1. AReduce the firm's tax liability on dividends
  2. BIncrease the firm's current ratio
  3. CLink managers' rewards to shareholder wealth so that their interests are alignedCorrect
  4. DEliminate the need for any audit of the firm

Explanation

Stock options tie managerial pay to share price, so managers gain when shareholders gain. This is an incentive (bonding) mechanism. It does not remove the need for audit, nor is it designed to change tax or liquidity ratios.

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