1. In 2002, Congress held hearings to investigate the collapse of Houston-based energy giant Enron Corp., aiming to discover how to protect against similar disasters. The spectacular implosion of Enron led to the largest corporate bankruptcy in US history and billions of dollars in losses for investors in the company's debt and equity securities. According to a 217page report from a panel of Enron's independent directors, Enron's former CEO Andrew Fastow and former chief executive Jeffrey Shilling devised a complex scheme involving limited partnership arrangements that allowed some of the company's top executives to take millions of dollars 'they should never have received.' The document also revealed that Enron's former chief executive and chairman Kenneth Lay personally approved partnership arrangements that led to enormous liabilities being kept off of Enron's balance sheet, thereby misleading investors as to the company's financial soundness. Enron's collapse was not only scrutinized by more than a dozen Congressional committees, but it also became the subject of a criminal investigation by the US Department of Justice.

• A. Explain how the Enron fiasco can be seen as a manifestation of the other people's money problem.
• B. How could it have been avoided?

2 . Warren Buffett, the chairman and CEO of Berkshire Hathaway, Inc., is an outspoken critic of executive stock option plans, at least as they are commonly employed. In a typical stock option plan, top executives are given the right to buy company stock at the current price for a period of up to 10 years in length. Such options have obvious economic value given the 10 +per cent long-run rate of return on common stocks. Nevertheless, the costs of executive stock option-based compensation are typically not reflected in the company's income statement.

• A. Explain how the failure to include stock option-based compensation costs in the firm's income statement could lead to a type of information asymmetry problem.

• B. How could the potential for such a problem be avoided? In other words, how would you design an effective executive stock option-based compensation plan?