How Disney dealt with the Principal Agent Problem: In 1984, the Walt Disney Comp
ID: 1173074 • Letter: H
Question
How Disney dealt with the Principal Agent Problem: In 1984, the Walt Disney Company brought in Michael Eisner, a Paramount executive as CEO. The firms board of directors agreed to pay Eisner a salary of $750,000, plus a $750,000 bonus for signing on, plus an annual bonus equal to 2 percent of the dollar amount by which the firms net income exceeded the 9 percent return on shareholders equity. In addition, he received options on 2 million shares of Disney stock, which meant that he could purchase them from the firm at any time during the five year life of the contract for only $14 per share. (15 Points)
a. At the end of 1984, shareholders equity was about $1.15 billion. How much would Eisners 1985 bonus have been if Disneys net income that year were $100 million? If it were $200 million?
b. In 1997, the price of Disney stock rose to about $20 per share. What was the capital gain value of Eisners stock options?
c. Eisners bonus was $2.6 million in 1996 and $6 million in 1987. Including the stock options he exercised, his compensation in 1988 was about $41 million, a record at that time for any U.S. executive. In 1993, his total compensation was about $202 million, again a record. Had Disneys owners provided a substantial incentive for Eisner to work hard to increase the firms profit?
d. A shareholder who invested $100 in Disney stock at the beginning of Eisners tenure would have seen its value rise to $ 1,460 in 1994. Was this why there was no substantial outcry from the firms owners about Eisners compensation?
How Disney dealt with the Principal - Agent Problem: In 1984, the Walt Disney Company brought in Michael Eisner, a Paramount executive as CEO. The firm's board of directors agreed to pay Eisner a salary of $750,000, plus a $750,000 bonus for signing on, plus an annual bonus equal to 2 percent of the dollar amount by which the firm's net income exceeded the 9 percent return on shareholder's equity. In addition, he received options on 2 million shares of Disney stock, which meant that he could purchase them from the firm at any time during the five year life of the contract for only $14 per share. At the end of 1984, shareholders' equity was about $1.15 billion. How much would Eisner's 1985 bonus have been if Disney's net income that year were $100 million? If it were $200 million? In 1997, the price of Disney stock rose to about $20 per share. What was the capital gain value of Eisner's stock options? Eisner's bonus was $2.6 million in 1996 and $6 million in 1987. Including the stock options he exercised, his compensation in 1988 was about $41 million, a record at that time for any U.S. executive. In 1993, his total compensation was about $202 million, again a record. Had Disney's owners provided a substantial incentive for Eisner to work hard to increase the firm's profit? A shareholder who invested $100 in Disney stock at the beginning of Eisner's tenure would have seen its value rise to $ 1,460 in 1994. Was this why there was no substantial outcry from the firm's owners about Eisner's compensation?Explanation / Answer
9% of $1.15 billion = $103,500,000
Now when income if $100,000,000, there would be no income from this source for Eisner as all the income will be distributed among the shareholders only.
If the income is $200,000,000 then the excess is
$200,000,000-$103,500,000 = $96,500,000
The annual bonus for 1984 = 2% of $965,00,000
= $1930,000
Total bonus = $750,000+ $1930,000 = $2680,000
2. The market value is $20 per share, but he got 2 million shares @$14 per share.
Therefore his profit on this part of his compensation will be 2,000,000 * $(20-14) = $12,000,000
If these shares were selling below $14 per share, then these shares would have been worth less for him, however as the price is higher than than $14, he made a huge profit out of them as well.
3. As his compensation policy was directly linked to the performance of the company, his increasing compensation is a proof that in his tenure he made such decision for the company that proved to be beneficial for the shareholders as well as for him too. This increased profits shows that the compensation policy adopted by Walt Disney was successful in creating profits for the company.
4.As the agent’s compensation is directly linked with the principle’s interest, then the agent works in alignment with the company’s goals. Now we have seen that though the performance incentives for Eisner was increased year by year, it was attributed to the increased wealth of the shareholders as well. Thus the shareholders wealth was increased from $100 in 1984 to $1460 in 1994, along with the increase in the compensation of the Eisner.
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