Designing a Managerial Incentives Contract Essay

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Pages: 6
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Question1:

High CEO Effort;
Expected shareholders’ value = $1,000,000,000(0.3) + $800,000,000(0.4) + $500,000,000(0.3) = $770,000,000

Low CEO Effort;
Expected shareholders’ value = $800,000,000(0.3) + $500,000,000(0.4) + $300,000,000(0.3) = $530,000,000

Improved shareholders’ value due to high CEO effort;
Amount worth to shareholder for high CEO = $770,000,000 - $530,000,000 = $240,000,000

Question 2:

Payment of bonus should be based on 1% of the improvement from high CEO effort
Bonus to CEO = $240,000,000 X 1% = $2,400,000

To ensure highest shareholders’ value, the performance level triggering this bonus should be $1,000,000,000
The price per share = $1,000,000,000 / 10,000,000 …show more content…
e) The CEO might just take strategies to minimize risks and cost saving measures to maintain the current shareholder value of $650,000,000 or not less than $500,000,000 to achieve the target as they foresee bad luck. Therefore, the company’s potential to growth from various opportunities might be ignored by the CEO.

Question 5:

Shareholder's value gained with perfect forecasting info = $240,000,000 Shareholder's value gained without perfect info = ( $800,000,000 - $500,000,000 ) 0.4
(medium luck) = $120,000,000 The amount pay to auditor = ( $240,000,000 - $120,000,000 ) 1% = $ 1,200,000

Question 6:
The stock option incentive-based or employee stock option is a call option on the common stock of a company, issued as a form of non-cash compensation. One of the purposes of the issuance of this stock is to align the employee's interest with those of the business' shareholders. If the company's stock rises, holders of options generally experience a direct financial benefit or vice versa. This motivates the employee to work harder for his/her own benefit while to create benefit for other shareholder at the same time.
For the stock option with exercise price of $70, the compensation committee expecting the shareholder value increase to $1,000,000,000 or $800,000,000 as the CEO would be able to get the bonus only after the share price reach higher than $70.
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