Financial Risk Manager Part 1

Explanation

A remuneration structure that includes bonuses based on share prices can potentially lead to agency risk. This is because such a structure may incentivize management to take on excessive risk in an attempt to boost the company's stock prices. The desire to increase their personal bonuses may lead managers to make decisions that are not in the best long-term interests of the company or its shareholders. This misalignment of interests between the managers and the shareholders is the essence of agency risk.

Why Other Options Are Incorrect:

• Choice A: Compensation with bonuses based on long-term revenues and objectives is not likely to contribute to agency risk. This type of compensation structure aligns the interests of management with those of the organization, as it incentivizes managers to work towards achieving long-term goals and objectives.

• Choice B: Compensation with no guaranteed bonuses does not necessarily lead to agency risk. In fact, this type of compensation structure can help mitigate agency risk by ensuring that managers are only rewarded when they achieve certain performance targets or meet specific objectives.

• Choice C: Compensation with a clawback clause on previous bonuses if the long-term goals are unachieved actually helps in reducing agency risk rather than contributing to it. The clawback clause acts as a deterrent for managers from taking excessive risks or engaging in short-term profit-making activities at the expense of long-term organizational goals.