Question (B) In many firms, managers' compensation is based on measures of managerial effort, namely, net income and share price. This requires managers to share the risk (of uncertain firm payoff) with shareholders and aligns the interests of owners and managers, thereby controlling the effects of moral hazard. However, Fama (1980) argues that incentive contracts such as those stated above are not needed.
Question (B) In many firms, managers' compensation is based on measures of managerial effort, namely, net income and share price. This requires managers to share the risk (of uncertain firm payoff) with shareholders and aligns the interests of owners and managers, thereby controlling the effects of moral hazard. However, Fama (1980) argues that incentive contracts such as those stated above are not needed.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Question
100%
A - Required
Explain in your own words, why the previous management increased production and inventories.
B - Required
Explain in your own words two reasons to support Fama's argument.
Transcribed Image Text:Question (A)
A producer of automotive components faces financial distress. Management
incentives are based on net income compared to the budget. There was a recent
change of management, which took place in early 2021. Unknowingly to the new
manager, the outgoing manager had sharply increased 2020 production, this led to
excessive levels of inventory on hand at the end of 2020. The producer uses
absorption costing( full costing) for its inventories.
Transcribed Image Text:Question (B)
In many firms, managers' compensation is based on measures of managerial effort,
namely, net income and share price. This requires managers to share the risk (of
uncertain firm payoff) with shareholders and aligns the interests of owners and
managers, thereby controlling the effects of moral hazard.
However, Fama (1980) argues that incentive contracts such as those stated above
are not needed.
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