PRIN.OF CORPORATE FINANCE >BI<
12th Edition
ISBN: 9781260431230
Author: BREALEY
Publisher: MCG CUSTOM
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Question
Chapter 12, Problem 13PS
a)
Summary Introduction
To discuss: The two following situations regarding stock-option packages.
b)
Summary Introduction
To discuss: The two following situations regarding stock-option packages..
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Suppose the compensation committee for a corporation is preparing to hire a new CEO and debating which of two pay packages to offer. Package A includes an annual salary of $1 million plus 1000 shares of stock. Package B also has a salary of $1 million, but has 10,000 options to purchase the company at its current price of $50.
a) Draw a graph showing the relationship between the CEO’s total compensation (vertical axis) and the stock price (horizontal axis) for the two pay schemes. Clearly label the two compensation methods in your graph.
b) Discuss how a switch from the stock to stock option plan would alter CEO behavior.
c) Discuss how a switch from the stock to stock option plan would affect the type of CEO that would be willing to accept the job.
An executive compensation scheme might provide a manager a bonus of $1,000 for every dollar by which the company’s stock price exceeds some cutoff level. In what way is this arrangement equivalent to issuing the manager call options on the firm’s stock?
Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers?
a. A firm's compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock.
b. The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period.
c. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.
d. The company's outside auditing firm is given a lucrative year-by-year consulting contract with the company.
e. Congress passes a law that severely restricts hostile takeovers.
Chapter 12 Solutions
PRIN.OF CORPORATE FINANCE >BI<
Ch. 12 - Prob. 1PSCh. 12 - Terminology Define the following: a. Agency costs...Ch. 12 - Prob. 3PSCh. 12 - EVA Here are several questions about economic...Ch. 12 - Accounting measures of performance The Modern...Ch. 12 - Economic income Fill in the blanks: A projects...Ch. 12 - Prob. 7PSCh. 12 - Prob. 8PSCh. 12 - Prob. 9PSCh. 12 - Prob. 10PS
Ch. 12 - Management compensation We noted that management...Ch. 12 - Prob. 12PSCh. 12 - Prob. 13PSCh. 12 - Prob. 14PSCh. 12 - EVA Herbal Resources is a small but profitable...Ch. 12 - Prob. 16PSCh. 12 - Economic income Consider the following project:...Ch. 12 - EVA Use the Beyond the Page feature to access the...Ch. 12 - Accounting measures of performance Use the Beyond...Ch. 12 - EVA Ohio Building Products (OBP) is considering...
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- 6. Stockholder and manager conflicts Executive compensation packages often tie performance to bonus and incentive awards, supplemental retirement packages, perquisites, and severance pay, in order to encourage the management team to align their performance with organizational goals. Which of the following compensation proposals is most likely to be in the best interest of the company’s shareholders? A base salary of $500,000 plus perquisites worth $250,000 A base salary of $500,000 plus a stock option package for 250,000 shares that mature in six months A base salary of $500,000 plus a stock option package for 250,000 shares, with 20% of shares maturing at the end of each of the next five years Vision Tech is a software company based out of San Francisco. Its stockholders are mostly individual investors and there is relatively little institutional ownership. If several pension and mutual funds were to take large positions in Vision Tech’s stock,…arrow_forwardCompensatory Share Option Plan Tom Twitlet, president of Twitlet Corporation, is considering establishing a compensatory share option plan for the companys 20 top executives. Tom wants to set the terms of the plan so that the number of options the executives can exercise increases based on a specified increase in the companys future earnings. Tom wants to make sure that the plan cannot be manipulated but, in addition, it should properly motivate the executives to stay with the company and make it successful. Given this concern, he wants to know how the increase in earnings should be specified: Should it be a dollar amount or a percentage change, and should the change in earnings be compared to the companys past results or against industry results? He also is interested in understanding how to determine the service period of the plan. Finally, Tom wants to understand the accounting for the plan and how it will affect the companys financial statements. Required: Prepare a memo to Tom that briefly explains the issues involved in specifying the terms used in the plan and accounting for the terms of this type of compensatory share option plan.arrow_forwardIn developing a compensatory share option plan, a company's objective is to motivate executives and employees to manage the company in a way that increases stock price. to decrease employee turnover. to enhance compensation packages without having to expend cash. to do all of these options.arrow_forward
- A limited is considering introducing an executive share option scheme. The scheme would be offered to all middle level managers of the company. It would replace the existing scheme of performance bonuses linked to the post tax earnings per share of the company. Such bonuses in the last year ranged between sh 500,000 and sh 700,000. If the option scheme is introduced, new options are expected to be offered to the managers each year. It is proposed that for the first year, all middle level managers be offered options to purchase 500,000 shares at a price of sh 5.00 per share, after the options have been held for one year. If the options are not exercised at that time, they will lapse. Assume that the tax authorities allow the exercise of such options after they have been held for one year. The company’s shares have a current market price of sh 6.10 per share. The dividend paid was sh 0.25 per share, a level that has remained constant for the last three years. Assume the dividends are…arrow_forwardA company wants to reward key employees and is considering a restricted stock plan. They have asked you for advice on whether there is an advantage to offering restricted stock units instead of a restricted stock award. What happens if you are fired, retire or die prior to the end of the vesting period?arrow_forwardIn a few sentences, answer the following question as completely as you can. Imagine you are the treasurer of a small manufacturing firm. Your firm is planning to go public (i.e., sell stock to investors for the first time). One unresolved question concerns the market’s required return on the stock. Given what you have learned, how do you think the required return will affect the market value of your firm’s stock? How would you go about estimating this rate?arrow_forward
- What kind of option can be used to incentive CEOs? Discuss the difference between stock option compensation and stock compensation.arrow_forwardWith respect to the shareholder/manager relationship, which of the following statements is FALSE? a. The managerial salary package should include an incentive component b. Executive stock options do not have expiration dates and are held in perpetuity c. Executive stock options tend to be issued out-of-money d. Performance shares can be used to align manager/shareholder interestsarrow_forwarda. How does the offering of stock options to CEOs attempt to align CEO incentives with shareholder incentives?b. Enron was a company that was ruined in part because of the stock options offered to upper management. Explain.c. In addition to accounting reforms, how might stock options be changed to try to prevent situations like what happened at Enron from occurring in the future?arrow_forward
- The rationale behind granting stock options is toinduce employees to work harder and be moreproductive. As the stock price increases (presumably due to their hard work), the employees sharein this added wealth. Another way to share thiswealth would be to grant shares of stock ratherthan options. What are the advantages anddisadvantages of using stock options rather thanshares of stock as employee incentives?arrow_forwardA CEO wants to create an ownership culture. The stock is trading at $50 per share. Which approach is best? A. Give every employee 1,000 shares of restricted stock B. Give stock to senior management who can influence profits C. Introduce a cash profit sharing program D. All of the above are equally good ways to create an ownership culturearrow_forwardA company might purchase treasury stock for all of the following reasons excepta. it wants to increase its net assets by buying its stock low and reselling it at a higher price.b. management wants to decrease the earnings per share of common stock.c. management wants to avoid a takeover by an outside party.d. the company needs the stock to distribute to employees as part of its employee stockpurchase plans.arrow_forward
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