Question $3$

Bebchuk and Fried $(2003)$ provide an overview of the main theoretical elements and empirical underpinnings of a $$managerial power$$ approach to executive compensation not only as an instrument for addressing the agency problem between managers and shareholders but also as part of the agency problem itself. The authors argue that boards of publicly traded companies with dispersed ownership cannot be expected to bargain at arm$$s length with managers. As a result, managers wield substantial influence over their own pay arrangements, and have an interest in reducing the saliency of the amount of their pay and the extent to which that pay is de$-$coupled from managers$$ performance.

Required

a$)$ Bebchuk and Fried$$s approach is an example of the application of Power Theory in the context of executive compensation.

i$.$ Provide two examples of the ways in which managers exert their power to camouflage excessive compensation received by them

ii$.$ How can financial reporting assist boards in controlling excessive power over management compensation?

b$)$ Fama $(1980)$ suggests that incentive contracts are not necessary. Why? What assumption does Fama make?

c$)$ Provide theoretical justification for the use of incentive contracts as part of executive compensation.

d$)$ Describe the two desirable properties of performance measures which could be used to design incentive contracts for managers. How does share price fare as a performance measure in terms of the two desirable properties?

e$)$ The board of ABC Company would like to design an incentive contract that would encourage managers to take steps to improve the long$-$run performance of the company over meeting short term targets. What recommendation would you provide to the board that might help it achieve its purpose?