NEWSWIRE - April 10, 2000

Topic: Agency Costs, Executive Compensation

Source: "Heads I Win, Tails I Win: More Companies Offer Bonus Payments that Aren’t Tied to Performance," by Rachel Emma Silverman, Wall Street Journal, Thursday, April 6, 2000, page R4; and "Pay for Outperforming: James Crowe, Chief of Level 3 Communications, Makes the Case for Linking Stock Options to Market-Beating Gains," by Joann S. Lublin, Wall Street Journal, Thursday, April 6, 2000, page R8.

Synopsis of Article: These articles, appearing in a special section on Executive Pay, provide an opportunity to discuss some of the theory and practice of pay for performance contracts. The first article discusses the current practice at many companies of providing guaranteed bonuses to many executives, independent of performance. The second article presents an interview with a CEO on the topic of indexed executive stock options. Alfred Rappaport has argued for indexed executive stock options in his article, "New Thinking on How to Link Executive Pay with Performance," published in the Harvard Business Review. These articles can be linked to a discussion of agency issues between managers and shareholders and how executive compensation contracts may be used to reduce agency costs.

Questions:

1. How can executive compensation contracts be used to reduce potential agency problems between managers and shareholders?

2. Why have many firms recently paid managers guaranteed bonuses that do not depend on performance? Is this good for shareholders?

3. Even if guaranteed bonuses are necessary, what other measures might be taken to link pay to performance?

4. A criticism raised in the first article is that compensation based on stock price does not reward an executive if Wall Street undervalues a businesses share price. How might executive stock options be modified to address this concern?