Question

Assuming they are awarded ethically and within the law, stock options are often touted as the perfect “alignment” mechanism for management incentives.

a) Why is that?

b) In the case of a multi-division corporation, sometimes “phantom stock” or options of phantom stock, will be issued in order to create a tangible measure of the performance of a specific division of the company. If you were trying to set a value for the phantom stock, how might you do it?

Answer 1

(a) Using stock options keep the employees of the comany vested into the organisation. Also there is felecibility in using it in different way to reward. Sicne these are provided price below than the market pirce so employee can directly benefit with the profit. It also gives a sense of ownership to the meployees so they are willing to work more for the comany.

(b)The value of phantom stock units is measured according to the value of the company stock. The value can be calculated through three methods which are - Appraised value ,Book value and Earnings formula.

I will used Earnings value formulas-
The first step is to calculate earnings before interest, income taxes, depreciation and amortization (“EBITDA”) which is used for the operating cash flows of the business.
Then this value of EBITDA is multiplied by a factor to determine enterprise value which can range from four to ten times of the EBITDA and it depends upon the industry, the market interest rate , the expected growth rate for the business, and many other factors.
Enterprise value is then reduced or subtracted by bank debt or toher liabilities and is increased by cash balances to determine equity value.
If it is a private company then equity value may be further reduced to reflect discounts for lack of marketability and/or control.