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CFA Level I · CFA Level I Exam · Corporate Governance: Conflicts, Mechanisms, Risks, and Benefits

Which mechanism is most likely to reduce the agency conflict between managers and shareholders?

Long-term equity-based compensation that vests over several years is most likely to reduce the conflict. It ties managers' wealth to the company's share value over time, aligning their interests with shareholders and discouraging short-term behavior. Fixed pay and weaker board independence do not improve alignment or monitoring.

  1. AGranting managers a fixed salary with no variable pay
  2. BAwarding managers long-term equity-based compensation that vests over several yearsCorrect
  3. CReducing the independent directors on the board

Explanation

Long-term equity pay ties managers' wealth to shareholder value over time, aligning interests. Fixed salary gives no link to performance, and fewer independent directors weaken monitoring.

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