Providing stock options to corporate managers was an idea designed to:

Question

BlackTom AI · Accepted Answer

Stock options tie executives’ personal wealth to the firm’s stock price, thereby aligning their incentives with shareholders.

1. Relevant knowledge points and concepts
- Principal-agent (agency) problem: managers (agents) may take actions that benefit themselves at shareholders’ (principals’) expense because their pay is not fully linked to firm performance.
- Moral hazard: after being hired, an agent may exert less effort or pursue private benefits if incentives are misaligned.
- Compensation design: linking pay to firm performance (e.g., stock options) is a common mechanism to reduce agency costs by making executives internalize the consequences of their decisions.

2. Step-by-step reasoning process
- Identify the problem: shareholders want managers to maximize firm value; managers may prefer private perks or short-term actions that boost their pay but lower shareholder value.
- Consider a remedy: provide compensation that increases when firm value increases.
- Evaluate stock options: an option gives managers the right to buy shares at a fixed price; if stock price rises, the option’s payoff increases, so managers benefit directly from increases in shareholder wealth.
- Conclude that this creates incentives for managers to take actions that raise long-term stock price, reducing the divergence between manager and shareholder objectives.

3. Calculations
No numerical calculation is required here. Conceptually, option payoff = max(0, stock price − exercise price); as stock price increases, manager payoff increases.

4. Why the correct answer is correct
Because stock options make a portion of managerial compensation contingent on stock performance, managers gain when shareholders gain, so their interests become aligned.

5. Why other options are incorrect
- “Hide increases in pay of corporate executives from stockholders.” Stock options are disclosed compensation forms; they are not primarily intended to hide pay.
- “Treat the free-rider problem.” The free-rider problem relates to collective action among many investors; stock options address incentive alignment for managers, not shareholder collective-action issues.
- “Treat adverse selection.” Adverse selection concerns hidden information before a contract (e.g., hiring based on unknown quality). Stock options address post-hiring incentive problems (moral hazard), not pre-contract information asymmetry.

6. Conclusion
Therefore the correct answer is: Align managers' interest with the stockholders' interest. This matches the provided answer.

Providing stock options to corporate managers was an idea designed to:Single choice

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