You have been retained by a large Internet-based firm to advise the compensation committee on how best to compensate the chief executive officer (CEO). The CEO is risk-averse and his actions are not...

You have been retained by a large Internet-based firm to advise the compensation committee on how best to compensate the chief executive officer (CEO). The CEO is risk-averse and his actions are not fully observable (hidden-action problems). The Internet firm is currently generating tax losses, but if some investments prove successful, it will begin paying taxes in 3 years. What issues must the firm consider, and how might it structure a compensation contract that takes into account the manager’s risk aversion and hidden actions and the tax positions of both the company and the CEO?