Question

The following statement was made by the vice president of finance of The Electric Company: "The managers of a company should use the same information as the shareholders of the firm. When managers use the same information in guiding their internal operations as shareholders use in evaluating their investments, the managers will be aligned with the stockholder's profit objectives."

Please respond to the vice president's statement....

Answer 1

Check the following explanation.

Step-by-step explanation:

The goals of managers and shareholders are not always aligned. Agency theory suggests this misalignment creates the need for costly monitoring through compensation contracts.

To align the goals of the two parties,compensation contracts should be designed to motivate the executive to make decisions that will not only increase his or her wealth, but will also increase shareholder wealth. Steps taken to increase shareholder wealth should be reflected in improved firm performance.Including both components in the contracts helps ensure the decisions of the executive are linked to various time horizons.

Shortterm components motivate the executive to make decisions that have an immediate affect on the firm. Long-term components are necessary to lengthen the decision horizon of the executive and enhance the likelihood of continued improvement in firm value. The long-term incentives in these contracts can be based on improved shareholder wealth as well as improved firm performance.