Reference no: EM132576629

The following excerpt is from a paper called "Current Global Financial Crisis: An Incentive Problem" by Pascual Beronee; IESE Business School - University of Navarra, Barcelona Spain.

• This article discusses the global financial crisis as a consequence of common (although inadequate) corporate governance practices. More specifically, it indicates that stock options lead to excessive risk taking, like subprime mortgage securities, because they have no penalty for the manager nor damage to her/his wealth in the case of collapse. "In tandem, golden parachutes and other exit packages incite termination of the employment contract since they reward failure, providing little incentive for the executive to perform adequately...."
• "One of the problems of stock options and similar instruments is that executives rewarded with stock options benefit when the stock price rises but experience no reduction in real wealth if the stock price declines. Managers may respond to these instruments with excessive risk-taking actions since they would not see their wealth damaged in the ease of stock price drops. This is probably the main reason why companies like Lehman Brothers, Fannie Mae or Freddie Mac got involved in very risky ventures like mortgage securities."

Required

Question 1: In terms of Management Control Systems and Agency Theory, discuss how these types of compensation schemes might cause managers to deviate from the stewardship role that is delegated to them by the shareholders. Also, explain how than are corporations through management able to fulfill the organizations' strategy.