1. Management compensation We

1. Management compensation We noted that management compensation must, in practice, rely on results rather than on effort. Why? What problems are introduced by not rewarding effort?

2. Management compensation Here are a few questions about compensation schemes that tie top management’s compensation to the rate of return earned on the company’s common stock.

a. Today’s stock price depends on investors’ expectations of future performance. What problems does this create?

b. Stock returns depend on factors outside the managers’ control—for example, changes in interest rates or prices of raw materials. Could this be a serious problem? If so, can you suggest a partial solution?

c. Compensation schemes that depend on stock returns do not depend on accounting data. Is that an advantage? Why or why not?

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