PAM_334_Fall_2008_Lecture_20 - PAM3340 Lecture20...

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PAM 3340 Lecture 20 Announcements: PS #4 and Memo #3 due Thursday Final: December 18th at 2PM Will cover all lectures/guests Will NOT cover D&L; K&L; or SOX readings  Will cover all others (including merger papers) Will cover Jensen & Meckling through p 333
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Lecture 20: Agenda Options Begin Jensen and Meckling paper on  agency costs
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 Lecture 20 Recall Points on CEO Pay: Pay helps to solve the principal-agent problem Includes salary, bonus, restricted stock, options Shareholders want pay linked to firm  performance: inherently variable CEO wants secure pay (risk averse): tension
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Note Figure 1 Use of options increased rapidly in 1990s Use of options recently declining CEO and top 5 employees account for  small fraction of total grant! Managers below top 5 have received an  increasing share  of option grants Options dilute current shares outstanding
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Hall and Murphy (con’t) from $3.5 million in 1992 to $14.7 million in  2000 Most due to rising value of stock options: from  average of $800,000 in 1992 to $7.2milll. in  2000 CEO pay fell to $9.4 mill. in 2002 due to drop  in option value Increase in option pay not limited to top  executives
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Breakdown of grants by  industry Table 1  – Breakdown of option use by  industry Divides into “Old Economy” versus  “New Economy” New economy: computers, software,  Internet, telecomm, networking
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Breakdown of grants by  industry (con’t) Between 1993 and 2000, grants in old  economy stocks increased 44 percent Between 1993 and 2000, grants in new  economy stocks increased 75 percent Financial services and utilities increased  about 50 percent
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Options Repricing P. 54  – “Companies with declining stock  prices have routinely “repriced” their  existing employee stock options, either  by resetting the exercise price or  (equivalently) by replacing old options  with new options at a lower exercise  price.”
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Consider Costs/Benefits of  Options   Consider Benefits of Options : Options provide  direct link  between comp.  and stock price performance Allows firm to attract motivated and  entrepreneurial employees Companies expend no cash Options can create incentives to stay at  firm Can encourage employee risk-taking
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Consider Costs of Options Options may contribute to excessive  risk-taking and excessive focus on the  short-term stock price Options can create incentives to  manipulate earnings
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Are Options Efficient?
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PAM_334_Fall_2008_Lecture_20 - PAM3340 Lecture20...

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