After reading the following short article, answer the subsequent question with one or two
sentences:
Question:
Why were stock options introduced?
Article:
Solving The Principal Agent Problem: Apple Insists That Executives Must Hold Company Stock
Over the years there have been a number of attempts at solving the principal/agent problem. Apple's the latest to try and do so and it has to be said that their attempt is likely to avoid most of the problems of earlier ones.
The basic problem is that we often hire people to do things for us, on our behalf. We are the principals and those we've hired are our agents. Obviously we do this because other people have skills that we do not and we want those skills: it's the division and specialisation of labour all over again.
However, we run into a problem because the incentives to the agent aren't necessarily going to lead to the behaviour which best benefits the principal. A lawyer being paid by the hour has an incentive to do things slowly when the client's interest might be best served by doing it rather more quickly, as one, terribly trivial, example. And this problem obviously exists in large corporations. What is in the best interest of the management is not necessarily the same as what is in the best interests of the shareholders. And the shareholders are the principals here and the management the agents. You wouldn't have to look around very far to find managements with small fleets of corporate jets for example: rather more than you would expect if they only ever got bought and used when truly, absolutely, necessary.
There have been a number of fads in trying to address this problem. This is how stock options started out for example. Incentivize the management to grow the stock price, something in the shareholders' interests, by letting them profit out of having done so. It isn't just howling lefties who think that one has got a little out of hand. Similarly, cash bonuses for meeting certain targets. The targets are all too easy to fiddle if we're to be honest. And they do tend to be set at levels that doesn't take rocket science to hit either.
Which brings us to Apple's idea:
Apple Inc. AAPL in February reversed its stance on a corporate-governance measure related to executive compensation, implementing a new rule that executive officers must hold triple their base salary in company stock.
...
Apple's new policy requires executive officers to hold three times their annual base salary in stock, and executives have five years to satisfy the requirement. The document also restates the company's existing policy of requiring the chief executive to hold 10 times his annual base salary and nonemployee directors to hold five times their annual retainers, policies that were mentioned in the January proxy.
There is rather the merit of simplicity to this. Instead of looking for a proxy to share ownership, those options, price targets for shares and so on, why not simply align incentives by insisting that the management, the agents, must be substantial shareholders and thus also be principals. Sounds like a decent enough plan to me I must admit.
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