Chapter 15: Incentive Compensation
GRANTING STOCK OPTIONS
Discussion Question Answers:
1. It is not obvious that the stock plan will provide strong incentives to unit managers.
Individually each manager has only a small effect on the stock price of the company. Thus, a
2. A more direct way to motivate the managers is to compensate them based on some
performance measure under their individual control. Examples might include unit sales, unit
THE DEBATE OVER CEO COMPENSATION
Discussion Question Answers:
1. It is true that CEOs are paid highly relative to rank-and-file employees. The statistics,
however, are often overstated since they focus on the highest paid CEOs and often include
payoffs from option contracts accumulated over a multi-year period. High salaries do not
necessarily imply that CEOs are overpaid and that firm value would increase if CEO pay were
2. No. They are in arguably in different labor markets. Historically, few CEOs in Japan ever
shift firms. Also, Japanese CEOs are arguably less important than in the US. In Japan, top
3. Some people argue that this figure seems low. A theoretical paper by J. Haubrich, however,
suggests that the figure is within the range of what is predicted by simple economic theories,
4. This is one potential explanation for the observation. However, the stock price might also
5. Chapter 14 described how some firms provide incentives via promotion tournaments.
Employees work harder in order to win promotions. The ultimate promotion is to become CEO.
Because the probability of eventually becoming CEO is relatively small, the prize for winning
(CEO pay) must be very large. As firm size increases, the number of employees competing to
INSURANCE DISTRIBUTION SYSTEMS
Discussion Question Answers:
1. The multitask arguments suggest that auto insurance agents are more likely to be employed
in-house than life insurance agents. Life insurance agents focus on selling policies. Effort on this
task can be motivated by commissions. Economies of scope can motivate an arrangement where
Auto insurance agents are involved in more tasks — both selling and ongoing customer service
are important. Excessive commission rates for auto insurance agents can provide incentives to
sell policies at the expense of after-sales service (especially if the agent does not expect to be
assigned to the same customer over a long time period and thus has little concern for future
sales). If a company pays an independent agent a fixed fee for selling and providing customer
service, the agent will tend to promote other companies’ products where the agent receives a
2. By separating the two tasks it is potentially easier to motivate higher levels of effort and a
better balance between activities. Sales can be measured and compensated by commissions.