However they encourage excessive risk taking if prices fall below exercise and

However they encourage excessive risk taking if

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- However, they encourage excessive risk taking if prices fall below exercise and misrepresentation of finances. - Prevent them from being too cautious - Options only has an upside: has a floor (won’t lose anything but can gain) 3. In 1999 and 2000, U.S. executives earned spectacular rewards from their options. Was this a sign of good management? This year their rewards are likely to be much more modest. Has the quality of management fallen? Does this suggest a problem with this form of incentive? How might it be fixed? - Tech boom in those years - No, the stock market in general rose during that period so most stock prices would have gone up even if the managers were mediocre. “This year” (assuming bad year for stocks) all prices are down, which also doesn’t indicate anything about managers’ performances. - This suggests that stock options should take into account general trends in stock prices and reward performance relative to the general industry. - Dot com bubble -> if you had options in anything, you’d have profits - Fix this by structuring option to be relative to others in the same industry 4. How are some of the ways managers have corrupted the use of stock options? Has this created some bad incentives? - Unwinding: managers can cash out options as soon as they are vested; allowing hedging (ex. invest in derivative that allows them to profit from decrease of share’s price -> can profit from both an increase and decrease in the option) - Resetting: prices reset when company’s shares fall - Managers can profit from increase in share price no matter where they started from (could have been an overall drop) -> profit from volatility - Reloading: letting executives exercise options when share price is high, at the same time granting new options with the old expiration date Managers have corrupted the use of stock options to disguise their true compensation from the public. - Backdating options after stock price rise is one way of doing this, as it allows managers to take a chance and profit only if it turn out to be profitable. It allows the company to appear to be paying the executive less when it initially borrows, but then increase the compensation with these options afterward.
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- Backdating: gives managers money for sure independent of anything they do; stock has gone up or you know it will go up, pretend that an option was given months ago - Stock-options reward mediocrity in that they don’t take into account general rises in stock prices, so it is unclear whether manager action or the economy was responsible for profit. There is no variety in the exercise price of options, which would provide the ability to fine-tune the incentive. Most exercise prices are set at market price. The incentive effects of options are undone if executives expect prices to be reset when the company's shares fall, which is a common practice (resetting/repricing).
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