Managing incentive schemes in a corporate environment

Peter Christoffersen

Student thesis: Master thesis


This thesis investigates the effectiveness of various incentive schemes in terms of their ability to reduce the moral hazard problem faced between Principals with asymmetric information. By setting the standard static Budget as a benchmark: Stock Options, Dynamic target setting models, Balanced Scorecards and WACC based performance metrics are evaluated in terms of their relative ability to mitigate the weaknesses induced from: external noise, accounting manipulation, limited duration and risk adverseness costs. Stock Options were found to be the weakest performance drivers due to their strong influence from external factors. By using OLS the external noise was estimated to be significantly higher than that of the traditional static budget. Further to that Stock Options opened up for new kinds of accounting complexity which does not exist if internal account are used. Dynamic targets were found to be more efficient than both the Budget and Stock Options since the regression equation could be used to eliminate a high degree of external noise and thus allow for a better estimation of the performance of the Agent. Overall this model was found to be optimal since the level of complexity added was considered relative low. A model was made which allowed the balanced scorecard to be translated into a structure comparative to that of an option – or more precisely a portfolio of options. It was concluded that by the use of the Balanced Scorecard, combined with dynamic targets, the highest degree of mitigation could be achieved, although this would then come with a relatively high price in terms of added complexity and additional cost to the incentive program. Due to the same complexity argument WACC based performance metrics were in general not seen as optimal performance drivers.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
Publication date2011
Number of pages103