FINC201 Finance | Time-Series Compensation Incentives Trends

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FINC2012- Corporate Finance

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Assignment

The principal-agency problem between shareholders (the principal owner of the firm) and executives (the agents) has been a central issue in corporate governance of public corporations. If managers are self-interested and there are no effective monitoring mechanisms, managers are likely to use their discretion to benefit themselves personally, at the expense of the shareholder value. These detrimental activities include empire building, over-investment of free cash flow and managerial entrenchment. These value destroying activities are the focus of this assignment. There is no need to examine the other problems described in the week 6 lecture slides 5 and 6. Seminal studies (Jensen and Meckling, 1976; Holmstrom, 1979) suggest that executive compensation structures that align managers’ interests with those of shareholders’ are the potential solution of the agency problem.

Task 1

From your research in the finance literature starting with the recommended readings below, describe the executive compensation structures designed to cope with the principal-agency problem. Are these structures effective? Are there any associated problems?

Task 2

Identify three appropriate peer firms for your allocated firms. Use the data provided to first identify by the Fama-French 49 industry classification and then by similar size (total assets or market capitalization). Do not add another criterion (e.g: profitability) as its unlikely you will find a match with 3 criteria. Use the data provided to study the five-year trends in CEO compensation structures, profitability and stock performance of your allocated firm and the three peer firms. Use these trends for the following tasks:

- Describe the time-series compensation incentives trends of your allocated firm and compare these trends of your allocated company with those of the peer companies.

- Provide your assessment on how these compensation structures affect firm performance.

FINC2012- Corporate Finance

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