Question: You have been retained by a large Internet based firm to advise the compensation committee on how best to compensate the chief executive officer (CEO).

You have been retained by a large Internet based firm to advise the compensation committee on how best to compensate the chief executive officer (CEO). The CEO is risk averse and his actions are not fully observable (hidden action problems). The Internet firm is currently generating tax losses, but if some investments prove successful, it will begin paying taxes in 3 years. What issues must the firm consider, and how might it structure a compensation contract that takes into account the manager’s risk aversion and hidden actions and the tax positions of both the company and the CEO?

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