Market-based compensation provisions are well suited to control the effort and horizon problems, since the market value of the stock reflects the present value of the entire future stream of expected cashflows... Because the expected payoff to stock options increases with stock price variance, options provide the manager with incentives to invest in projects that increase the riskiness of the firm's cash flows. Options thus help control the managers' incentives to take too little risk. Stock options also help control the underleverage problem. Higher leverage becomes more attractive to the manager since it increases the variance of the equity and thus the value of the options.
Wednesday, 16 December 2009
This may have dated a little...
Michael Jensen on remuneration (from this):