1. You serve as an outside director for the Supplies, a multi-billion dollar ent
ID: 1175013 • Letter: 1
Question
1. You serve as an outside director for the Supplies, a multi-billion dollar enterprise. You have been assigned to the Compensation Committee, which is being formed in response to outside pressure from shareholders. You note the following. First, activist organizations like CALPERS have a strong bias towards using options as an incentive compensation for management. Second, there are a number of scandals involving the use of options for compensation. Please discuss the policy arguments for aligning the compensation for the top-level executives to the future performance of the company, and reconcile if possible the two items noted above. 1. You serve as an outside director for the Supplies, a multi-billion dollar enterprise. You have been assigned to the Compensation Committee, which is being formed in response to outside pressure from shareholders. You note the following. First, activist organizations like CALPERS have a strong bias towards using options as an incentive compensation for management. Second, there are a number of scandals involving the use of options for compensation. Please discuss the policy arguments for aligning the compensation for the top-level executives to the future performance of the company, and reconcile if possible the two items noted above. 1. You serve as an outside director for the Supplies, a multi-billion dollar enterprise. You have been assigned to the Compensation Committee, which is being formed in response to outside pressure from shareholders. You note the following. First, activist organizations like CALPERS have a strong bias towards using options as an incentive compensation for management. Second, there are a number of scandals involving the use of options for compensation. Please discuss the policy arguments for aligning the compensation for the top-level executives to the future performance of the company, and reconcile if possible the two items noted above.Explanation / Answer
The policy arguments for aligning the compensation for the top management and top level executives to the future performance of the company is based on the rationale that when a part of the compensation is based on options then it gives a sense of ownership to the executives of the company. The executives of the company are agents of the company and their interests may not always be the same as the interests of the principals (i.e. the shareholders). However when executives are rewarded through schemes like stock options their interests becomes aligned with the interest of the shareholders and hence the actions and decisions of the executives will be focused towards value maximization.
To reconcile the two situations given in the question the organization should use options for incentive compensation even for the other level of employees, apart from the top executives. The middle and junior level employees can be given a smaller percentage or number of shares, when compared to the top level executives. This will align their interests as well. Secondly, to minimize the chances of a scandal, the company should put in place strong mechanisms for internal control. There should be proper control mechanisms in place, risk assessment should be done and the company’s control environment should be augmented. This will help in ensuring that chances of a scandal rising is minimized.
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