Review Questions

1.
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Describe the main properties of executive compensation over the last 30 years or so.
2.
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What is meant by a stock option? Why are stock options such an important component of realized executive compensation levels?
3.
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Suppose that a CEO has an option contract that allows him or her to purchase 10,000 shares at the original grant price of $100 per share. If the option is about to expire and the current share price is $80 per share, then what is the CEO's optimal course of action?
4.
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Explain why honoring bonus payments is an important business concern in cases of circumstances characterized by relational contracts. Given this, what problems would AIG have confronted if it had simply withheld its bonuses? (In fact, many executives received their bonuses but returned them; why does this potentially make a world of difference?)
5.
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If CEO pay is fully characterized by a model grounded on a perfectly competitive foundation, then why is it true that policy interventions that tamper with executive pay necessarily do more harm than good?
6.
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Under conditions of imperfect information concerning managerial effort, CEO pay is governed by w = β0 + β1 ÅE V, where the βs are optimally chosen coefficients, and V is the firm's (stock) value. What factors explain why the firm uses V rather than the firm's accounting profits? Why is it the case that firms choose different values of β1, which governs the strength of the link between pay and performance?
7.
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According to the entrenchment hypothesis, executives have hijacked the pay-setting process, giving them the freedom to pay themselves exorbitant salaries. What are the conditions necessary for this to be the case? Are these conditions satisfied in practice?

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