Final answer:
To ensure management's decisions align with stockholders' interests, compensation is often tied to stock price or earnings per share, enabling shareholders to hold management accountable and aligning managerial incentives with shareholder value.
Step-by-step explanation:
When considering how to ensure that management decisions are in the best interest of stockholders, one common method is to tie management compensation to the performance of the company, which can be represented through the company's common stock price or the level of earnings per share. This alignment of interests is believed to motivate managers to act in the best interest of the shareholders, aiming to enhance company performance and, subsequently, shareholder value. Typically, shareholders of a public company elect a board of directors to make high-level decisions and oversee management, with the understanding that each share of stock provides a vote in these critical decisions. Bond issuance or bank loans provide capital at the expense of mandatory interest payments, while venture capitalists offer more intensive oversight and investment at the cost of substantial company ownership shares. Ultimately, whether through stock-based compensation or diligent stewardship by investors, the goal is to mitigate the risk of managerial decisions that could negatively impact shareholders' investments.