Executive options can be used to address the agency problem in corporations because:

Question

BlackTom AI · Accepted Answer

The question asks about why executive options can be used to address the agency problem in corporations.
First, recognize that executive stock options align managers’ incentives with shareholders’ interests by tying the managers’ wealth to the company’s stock performance. This creates a link between managerial decisions and the share price, which is the key channel through which the agency problem is mitigated.
Next, consider the provided correct statement: 'they motivate managers to make decisions that will increase the share price.' This captures the core mechanism: if managers benefit when the stock price rises, they are incentivized to undertake actions that improve value for shareholders, potentially reducing the divergence between management goals and shareholder value.
Since no other answer options are given in the provided data, we cannot evaluate each alternative. In a typical set, other options might discuss concerns like risk-taking, potential for short-termism, or the possibility of misaligned compensation if stock prices are volatile; reasoning through those would involve explaining why those scenarios could either support or undermine the agency-cost reduction depending on design specifics (e.g., vesting, performance horizons, or blackout periods).
However, with the single supplied assertion, the central idea to understand is the incentive alignment effect: stock-based compensation provides a pathway for managerial compensation to reflect firm value, thereby addressing the core agency tension between managers and owners.
In summary, the argument rests on the principal–agent theory premise: performance-based pay ties compensation to shareholder value, encouraging decisions that raise the share price, which is the primary mechanism by which executive options tackle the agency problem.

FINC5001 (ND) 1.8: Module 1 Practice Problems

Executive options can be used to address the agency problem in corporations because:

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