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Topic5-MalayMondal - MalayKumarMondal IIM,Lucknow options...

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W INNER CRISIL Y OUNG T HOUGHT L EADER 2010 Malay Kumar Mondal IIM, Lucknow Is Debt linked employee pay options a better idea than stock options?
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Table of Contents Executive Summary ................................................................................................................................. 3 1. Introduction .................................................................................................................................... 4 2. Parameters of Executive Compensation ......................................................................................... 4 3. Executive Stock Options .................................................................................................................. 4 3.1 ESO – Why it gained popularity? ................................................................................................... 4 3.2 Concerns with ESO ........................................................................................................................ 5 3.2.1 Literature Review ................................................................................................................... 6 3.3 Different ESO Policies .................................................................................................................... 6 4. Debt Linked Executive Pay Option .................................................................................................. 7 4.1 Literature Review .......................................................................................................................... 7 4.2 Benefits of Debt Linked Pay Option .............................................................................................. 7 4.3 Concerns with Debt Options ......................................................................................................... 9 5. Equity or Debt? ............................................................................................................................... 9 6. Conclusion ..................................................................................................................................... 10 Appendix I: Problematic Issues of ESO ................................................................................................. 11 References ............................................................................................................................................ 12 List of Illustrations Table 1: Different ESO policies ................................................................................................................ 7 Figure 2: Safeguarding both Lender and Shareholder Incentive by Debt Linked Compensation ........... 8 Figure 3: Cyclical Relation of Manager, Lender and Shareholder Incentive ........................................... 8 Figure 5: Debt or (D + E) Linked Compensation Evaluation .................................................................... 9 2 | P a g e Figure 4: Equity Linked Compensation Evaluation ................................................................................. 1
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Is Debt Linked Employee Pay Options a Better Idea Than Stock Options? Executive Summary Financial crisis and collapse of large firms has raised the “big question” on the applicability of equity based compensation. In this context debt is now being considered as an alternate approach. To compare the applicability of the compensation schemes I have identified four parameters – i) performance based compensation, ii) incentive to the executive, iii) safeguarding shareholder interest and iv) safeguarding other stakeholder interest. Neither debt nor equity based compensation qualified for the first parameter. Both these two components are market driven and beyond the control of managers. Again in case of equity, managers are induced to take higher risk to make higher profit as they are not concerned about the downside risk. So the lenders’ interest is at stake. Debt linked compensation takes care of this issue. Also as the lender’s incentive is tied with that of managers, lenders feel secure about their money and hence can offer money at a lower lending rate. This increases the bottom line of the firm and hence increases the shareholder value. In this paper I have pointed out that neither of these two methods can give optimal result. So I recommend to tie the compensation with performance matrix as it is under control of managers and also to do peers comparative compensation. 3 | P a g e
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