Which of the Following Bonus Schemes Would Be Appropriate for the Managers

question 1

Multiple Choice

Which of the following bonus schemes would be appropriate for the managers of a biotechnology research company?

• A) A market-based bonus scheme, as it is more appropriate to reward the manager in terms of the market value of the firm's securities, which are assumed to be influenced by expectations about the net present value of expected future cash flows, and the manager will be given an incentive to increase the value of the firm.
• B) A fixed basis scheme, so that the managers would not take great risks, reject risky projects, and be reluctant to take on optimal levels of debt as it may be beneficial to those with equity in the firm.
• C) An accounting-based bonus scheme as this will be in the interest of the manager, as that manager will potentially receive greater rewards and will not have to bear the costs of the perceived opportunistic behaviours.
• D) A combination of fixed basis and accounting-based scheme, as assuming that self-interest drives the actions of the managers, it may be necessary to put in place remuneration schemes that reward the managers in a way that is, at least in part, tied to the performance of the firm.

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Definitions:

Representativeness Heuristic

A mental shortcut that involves making a probability judgment by comparing an object or event to a prototype of the object or event.

Availability Heuristic

A cognitive bias that causes people to overestimate the importance of information that is readily available to them.

Hindsight Bias

The tendency to believe, after learning an outcome, that one would have foreseen it, known also as the "I-knew-it-all-along" effect.

Confirmation Bias

The tendency to favor, interpret, and recall information in a way that confirms one's preexisting beliefs or hypotheses.