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Unformatted text preview: ed transferability) attempt
to align the holder's interest with those of the business' shareholders.” 1
ESO are the rights to the employees to purchase the company stocks at a predetermined price,
known as strike price or exercise price between the vesting date and the exercise date. The
employees can not exercise their call option before the exercise date. 3.1 ESO – Why it gained popularity? ESO was strongly backed by theoretical concepts like principal-agent theory where the
shareholders are the principal and the management, the agent. Compensating the executives with 1 Wikipedia.org on 17th Nov 2010 4 | P a g e the company stock options reduce the conflict of interest between the two parties and encourage the
managers to increase the shareholders’ value by increasing the company stock value. Gomez-Mejia
et al 1987 and Bebchuk, Fried 2003 also suggested that the compensation scheme of the executives
should be aligned with the interests of the shareholders.
It is obvious that, for better functioning and performance of the firm the managers should be
incentivised and encouraged to do better. ESO was one means to do so.
Before the ESO era, the traditional approach was to monitor the executive behaviour and
performance which required legal stipulation of duties, checks and balances in one hand and both
time and duty of independent third parties on the other. Hence this process involved huge
transaction cost which may later complicate the issue of a well-functioning firm. ESO was the
remedy to this issue by tying up the executive compensation with the equity stock value. 3.2 Concerns with ESO It is in best competitive sense that employee compensation should be linked with their
performance. ESO has been popularly chosen to do so. But the stock price is determined by market
and market is not efficient enough to determine accurate stock prices. That raises questions.
The best method to measure firm performance is the firm value. Again the executives’
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This document was uploaded on 01/14/2014.
- Winter '14