Readings
Strategic Compensation: Chapter 11
Lee, D. Everything You Need to Know About Stock Options and RSUs. Harvard Business Review. 2021. https://hbr.org/2021/08/everything-you-need-to-know-about-stock-options-and-rsus (Links to an external site.)
“2.3 (Dis)incentives from Bonus Plans” and “2.4 (Dis)Incentives from Capital Markets” (Page 33-41) in Murphy, K. J. (2013). Executive compensation: Where we are, and how we got there. In Handbook of the Economics of Finance . https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2041679 (Links to an external site.)
Case: Equity on Demand: The Netflix Approach to Compensation. Harvard Business School Case #CG19-PDF-ENG. (This case is available for purchase on the Harvard Business Publishing website with this link: https://hbsp.harvard.edu/import/855127 (Links to an external site.) this is the one I uploaded
1. When an employee joins her organization, she gets an option to purchase 1000 shares with a strike price of $2 per share, and these shares vest over four years. One year later, the stock price is $3 per share. Two years later, the stock price is $4 per share. The employee then quits and exercises any vested options. Which of the following statements is true?
Group of answer choices
a. The employee exercises the option to purchase 500 shares, paying $2 per share.
b. The employee exercises the option to purchase 500 shares, paying $4 per share.
c. The employee exercises the option to purchase 1000 shares, paying $2 per share.
d. The employee exercises the option to purchase 1000 shares, paying $4 per share.
e. The employee exercises the option, purchasing 250 shares at $3 per share, and 250 shares at $4 per share.
2. According to Murphy, what are the problems from CEO’s bonus plans based on accounting measures? Would these problems be effectively mitigated by shifting from accounting- to equity-based plans?
3. What are the differences between stock options and RSUs? Which of them carries higher risk for employees?
4. Evaluate Netflix’s compensation program. In what ways is it more efficient than the more standard practice whereby the firm decides the compensation mix for employees? In what ways is it less efficient?
5. The new CEO of your company, hired on January 1, 2019, is paid a compensation package (excluding fringe benefits) consisting of 3 components: stock options, annual base salary, and bonus. The stock options grant is 30,000 stock options with a strike price of $75, expiring after 10 years and cliff-vested after 1 year (i.e., they can be exercised on or after January 1, 2020). Annual base salary is $200,000. The bonus is a typical “80/120” plan based on what the company’s “Earnings Before Tax” (EBT) is relative to a “Target Earnings Before Tax” (EBT0) that is set by the board of directors. Specifically, the CEO’s bonus function, f, is as follows:
Bonus = f(EBT) = 0 if EBT < 0.7×EBT0 = $150,000 + 0.1×(EBT – 0.7×EBT0) if 0.7×EBT0 < EBT < 1.2×EBT0 = $450,000 if EBT > 1.2×EBT0
Assume the following targets and actual performance of your company in the next two years:
12/31/19
12/31/20
EBT (actual)
$5.4m
$9.1m
EBT0 (target)
$6.0m
$7.0m
Stock Price
$81
$89
What is your CEO’s total pay in both years assuming he exercises his options as soon as possible?
Group of answer choices
a.2019: $650,000 2020: $1,070,000
b.2019: $650,000 2020: $1,190,000
c.2019: $470,000 2020: $1,190,000
d.2019: $470,000 2020: $1,070,000
