BMGT440ch23-highlights

BMGT440ch23-highlights - Options & Corporate Finance:...

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BMGT440– Dr. E F Kiss ch23- Options & Corporate Finance: Chapter 23 highlights
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BMGT440– Dr. E F Kiss ch23- Executive Summary This chapter extends the analysis of options contained in Chapter 22. We describe four types of options found in common corporate finance decisions. § Executive stock options § The option to expand embedded in a start- up. § The option in simple business contracts. § The option to shut down and reopen a project.
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BMGT440– Dr. E F Kiss ch23- Chapter Outline 23.1 Executive Stock Options 23.2 Valuing a Start Up 23.3 More on the Binomial Model 23.4 Shutdown and Reopening Decisions 23.5 Summary and Conclusions
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BMGT440– Dr. E F Kiss ch23- 23.1 Executive Stock Options Executive Stock Options exist to align the interests of shareholders and managers. Executive Stock Options are call options (technically warrants) on the employer’s shares. § Inalienable § Typical expiration (maturity) is 10 years. § Cannot be sold or transferred unless the employee dies, then the options transfer to the estate § Typical vesting period is 3 years. Vesting period during which they cannot be exercised & the employee loses the options if s/he leaves company § Most include implicit reset provision to preserve incentive compatibility. Executive Stock Options give executives an important tax break: grants of at-the-money options are not considered taxable income. (Taxes are due if the option is exercised.)
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BMGT440– Dr. E F Kiss ch23- Employee Stock Options Options that are given to employees as part of their benefits package Employee Stock Options (ESOs) allow employees to purchase company stock at a fixed price for a fixed amount of time. Often used as a bonus or incentive § Designed to align employee interests with stockholder interests and reduce agency problems § Empirical evidence suggests that they do not work as well as anticipated due to the lack of diversification introduced into the employees’ portfolios § The stock just is not worth as much to the employee as it is to an outside investor
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BMGT440– Dr. E F Kiss ch23- Valuing Executive Compensation FASB allows firms to record zero expense for grants of at-the- money executive stock options. § Back dated options for CEOs– WSJ , Fr. Nov. 17, p. A2 § http://online.wsj.com/article/SB116372847763825845.html?mod=tod § http://online.wsj.com/page/perfectpayday.html § http://online.wsj.com/public/resources/documents/info-optionsscore0 § http://online.wsj.com/article/SB116373005784725882.html?mod= todays_us_page_one However the economic value of a long-lived call option is enormous, especially given the propensity of firms to reset the exercise price after drops in the price of the stock. Due to the inalienability, the options are worth less to the
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This note was uploaded on 02/22/2011 for the course BMGT 440 taught by Professor White during the Spring '08 term at Maryland.

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BMGT440ch23-highlights - Options & Corporate Finance:...

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