What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?

What will be an ideal response?

Answer: Increasing the pay-for-performance sensitivity comes at the cost of burdening managers with risk. Besides increasing managers' risk exposure, increasing the sensitivity of managerial pay and wealth to firm performance has some other negative effects. For example, often options are granted "at the money," meaning that the exercise price is equal to the current stock price. Managers therefore have an incentive to manipulate the release of financial forecasts so that bad news comes out before options are granted (to drive the exercise price down) and good news comes out after options are granted. Studies have found evidence that the practice of timing the release of information to maximize the value of CEO stock options is widespread.
More recently, Erik Lie has found evidence suggesting that many executives have engaged in a more direct form of manipulating their stock option compensation: backdating their option grants. Backdating refers to the practice of choosing the grant date of a stock option retroactively, so that the date of the grant would coincide with a date when the stock price was at its low for the quarter or for the year. By backdating the option in this way, the executive receives a stock option that is already in-the-money, with a strike price equal to the lower price on the supposed grant date.