Moral hazard and equity finance. Be familiar with the so-called principal-agent problem and ways that it can be/has been addressed. Understand the free-rider problem associated with monitoring .

Be able to explain how compensating top management with put options on the company's stock can create distorted incentives.

Principal-agent problem arises when there is conflict of interest between the agents. Principal-agent problem is a particular type of moral hazard problem. In the free rider problem individual are intended to take the benefits without incurring the cost of consumption made by them.

The compensating top management with put options on the company's stock can create distorted incentives as such options have the greater value to the management but they carry higher risk with them. In such situations the investors have the incentive to trade in risky options to gain the higher returns. Increasing the risk level would lead to create distorted incentives to the investors.