In 1993, the Ontario Securities, Commission implemented new executive compensation disclosure rules (OSC, Form 40, Securities Act, Regulation 638/93). Similar requirements were already in place in the United States. These disclosure rules specified that shareholder proxy statements contain tables spelling out compensation for the five highest paid executives, plus a report from the board's compensation committee explaining the firm’s compensation practices. (The BCE Compensation Committee report in Exhibit 10.1 is an example of reporting under these rules.)

Required

a. To what extent do you think that such disclosure requirements will assist an efficient managerial labor market to work well? Explain. Include a definition of an efficient managerial labor market in your answer.

b. If the managerial labor market is fully efficient (that is, analogous to an efficient securities market), would manager incentive plans based on risky performance measures such as share price and reported net income be needed? Explain why or why not.

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Example 10.1 A Congruent Performance Measure Assume that the manager can work hard or shirk on both SR and LR effort, and that the net incomes and payoffs are as given in Table 10.1: Table 10.1 Expected Net Incomes and Payoffs for Congruent Performance Measure Manager's Effort Short-run Effort (SR) Long-run Effort (LR) Work Hard Shirk Work Hard Shirk Expected Net Income E(NI) $4 $1 $3 52 Expected Payoff E(x) $6 $1.5 $4.5 $3 if the manager allocates all effort to SR and works hard, expected net income is $4. However, some of this effort, such as cost control, may remain to benefit next period, assuming that at least some of the lower costs will persist. Let these future benefits amount to $2. Then the expected payoff from SR effort totals $6. If the manager works hard at LR effort, say, by devoting time to R&D, this generates expected net income of $3 currently but is expected to create additional payoff of $1.5 next period, for a total of $4.5. Similar comments apply if the manager shirks.