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Agency problem, compensation and bonuses, risk management

Relative to the agency problem, how do compensation and bonus policies impact risk management?
Given the recent controversies regarding executive compensation, should stock options and bonuses be eliminated?

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Let's look at each part of this.

When we look at the agency problem, we're taking into account the best possible decision for the company as opposed to what's best for an individual. When we have executives in charge, this becomes skewed because the executives will want to do what's best for the company and what's best for their own personal gain. This is where the agency problem becomes an issue. The agency issue requires executives to focus on the greatest good for the company, which will then benefit the shareholders and other stakeholders of the company. We then look at compensation and bonus policies as related to risk management. One of the key areas with compensation and bonus policies and risk management is that compensation structure for executives can create a situation where fraud becomes prevalent. We have seen this in the past decade, which was actually severe enough to cause the creation of various laws governing accounting, and in particular, compensation structures. We saw a surge where the IRS cracked down on what they believed to be unreasonable compensation to executives, and audited thousands of companies where they felt that it was not reasonable.

When we talk about ...

Solution Summary

Relative to the agency problem, how do compensation and bonus policies impact risk management?
Given the recent controversies regarding executive compensation, should stock options and bonuses be eliminated?

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