IAI Actuarial Core Principles · Business Finance · Corporate governance and the regulation of companies
A listed Indian company wants to align its senior managers' interests with those of shareholders. Which remuneration design is most likely to reduce the agency problem?
Share options vesting only if the share price beats an industry index over three years best align managers with shareholders, because rewards depend on long-term value creation relative to peers. Fixed pay, revenue-based bonuses, guaranteed severance and perquisites do not link rewards to shareholder wealth.
- AA fixed salary independent of company performance
- BShare options that vest only if the share price outperforms an industry index over three yearsCorrect
- CA one-year cash bonus based on revenue growth regardless of profitability
- DA large severance payment guaranteed on dismissal for any reason
- Free use of company vehicles and housing
Explanation
Options vesting on relative share price performance over several years tie managers' rewards to long-term shareholder value. A fixed salary gives no link. A revenue-based bonus can encourage value-destroying growth. Guaranteed severance rewards failure, and perquisites are themselves a form of agency cost.
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