An article in The Wall Street Journal discusses a trend among some large U.S. corporations to base the compensation of outside members of their boards of directors partly on the performance of the corporation. "This growing practice more closely aligns the director to the company. [Some] companies link certain stock or stock-option grants for directors to improved financial performance, using a measure such as annual return on equity."

(a) How would such a linkage tend to reduce the agency problem between managers and shareholders as a whole?

(b) Why could directors be more efficient than shareholders at improving managerial performance and changing their incentives?

(c) How does the concept of moral hazard apply to this situation and what policies can be put in place to mitigate it?

Answer rating: 100% (QA)

a By tying the compensation of external members on boards of directors to a companys performance managers and shareholders can reduce their agency pro... View the full answer