Question 7

Compensate managers with shares of stock in the firm

One effective way to reduce the negative effects of an agency problem is to compensate managers with shares of stock in the firm. This aligns the interests of the managers with those of the shareholders, as it incentivizes managers to act in the best interest of the company.

A) Increase the number of managers relative to stockholders

Increasing the number of managers relative to stockholders does not address the core issue of aligning interests. In fact, it may complicate decision-making and dilute accountability, potentially exacerbating agency problems rather than alleviating them.

B) Give pay raises to managers

While giving pay raises may improve manager satisfaction, it does not inherently align their interests with those of shareholders. Without a connection between compensation and company performance, this approach could fail to mitigate the agency problem.

C) Provide managers with higher sales commissions

Higher sales commissions may motivate managers to increase sales, but they do not necessarily align the managers' long-term goals with those of the shareholders. This could lead to short-sighted decisions that may not benefit the company in the long run.

D) Compensate managers with shares of stock in the firm

Compensating managers with shares of stock in the firm effectively aligns their interests with those of the shareholders, as both parties benefit from the company's success. This approach encourages managers to focus on long-term performance and shareholder value.

Conclusion

Compensating managers with shares of stock is a proven strategy to mitigate agency problems by ensuring that the interests of managers align with those of the shareholders. Other options, such as increasing the number of managers, providing pay raises, or offering higher commissions, fail to create this alignment and may even lead to further complications in governance and decision-making.