A typical annual and long-term management compensation plan tied to financial accounting numbers can contribute to agency problems within a firm in several ways. First, when a manager’s compensation is directly linked to their individual performance measures, such as hitting certain income targets or reducing costs, they may be more likely to engage in behaviors that could result in short-term gains for themselves at the expense of the company’s long-term objectives. For example, an overly aggressive cost cutting strategy might lead to short term savings but cause lasting damage by curtailing employee morale or damaging customer relationships.
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