Designing a Managerial Incentives Contract Specific Electric Co. asks you to implement a pay-for- performance incentive contract for its new CEO and four EVPS on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in reduced personal entrepreneurship and increased stress-related health care costs or they can reduce effort, thereby avoiding the personal costs. The CEO and EVPS face three possible random outcomes: the probability of the company experiencing good luck is 30 percent, medium luck is 40 percent, and bad luck is 30 percent. Although the senior management team can distinguish the three "states" of luck as the quarter unfolds, the Compensation Committee of the Board of Directors (and the shareholders) cannot do so. Once the board designs an incentive contract, soon thereafter the good, medium, or bad luck occurs, and thereafter the senior managers decide to expend high or reduced work effort. One of the observable shareholder values listed below then results. SHAREHOLDER VALUE GOOD LUCK (30%) MEDIUM LUCK (40%) BAD LUCK (30 High Effort $1,000,000.000 se00.000.000 S500.000.000 Reduced Efort s800.000.000 S500.000.000 s30.000.000 Assume the company has 10 million shares outstanding offered at a $65 initial share price, implying a $650,000,000 initial
Designing a Managerial Incentives Contract Specific Electric Co. asks you to implement a pay-for- performance incentive contract for its new CEO and four EVPS on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in reduced personal entrepreneurship and increased stress-related health care costs or they can reduce effort, thereby avoiding the personal costs. The CEO and EVPS face three possible random outcomes: the probability of the company experiencing good luck is 30 percent, medium luck is 40 percent, and bad luck is 30 percent. Although the senior management team can distinguish the three "states" of luck as the quarter unfolds, the Compensation Committee of the Board of Directors (and the shareholders) cannot do so. Once the board designs an incentive contract, soon thereafter the good, medium, or bad luck occurs, and thereafter the senior managers decide to expend high or reduced work effort. One of the observable shareholder values listed below then results. SHAREHOLDER VALUE GOOD LUCK (30%) MEDIUM LUCK (40%) BAD LUCK (30 High Effort $1,000,000.000 se00.000.000 S500.000.000 Reduced Efort s800.000.000 S500.000.000 s30.000.000 Assume the company has 10 million shares outstanding offered at a $65 initial share price, implying a $650,000,000 initial
Chapter12: Balanced Scorecard And Other Performance Measures
Section: Chapter Questions
Problem 2PA: Florentino Allers is the production manager of Electronics Manufacturer. Due to limited capacity,...
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Design an incentive plan that seeks to elicit high effort by granting restricted stock. Show that one-half million shares granted at $70 improves shareholder value relative to all prior alternatives.
Transcribed Image Text:Designing a Managerial Incentives Contract
Specific Electric Co. asks you to implement a pay-for-
performance incentive contract for its new CEO and four EVPS
on the Executive Committee. The five managers can either work
really hard with 70 hour weeks at a personal opportunity cost of
$200,000 in reduced personal entrepreneurship and increased
stress-related health care costs or they can reduce effort,
thereby avoiding the personal costs. The CEO and EVPS face
three possible random outcomes: the probability of the company
experiencing good luck is 30 percent, medium luck is 40
percent, and bad luck is 30 percent. Although the senior
management team can distinguish the three "states" of luck as
the quarter unfolds, the Compensation Committee of the Board
of Directors (and the shareholders) cannot do so. Once the
board designs an incentive contract, soon thereafter the good,
medium, or bad luck occurs, and thereafter the senior managers
decide to expend high or reduced work effort. One of the
observable shareholder values listed below then results.
SHAREHOLDER VALUE
GOOD LUCK (30%) MEDIUM LUCK (40%) BAD LUCK (30
High Effort
$1,000,000.000
se00.000.000
S500.000.000
Reduced Efort s800.000.000
S500.000.000
s30.000.000
Assume the company has 10 million shares outstanding offered
at a $65 initial share price, implying a $650,000,000 initial
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