Question

The shareholders meeting of the ABC Personal Computer Company is coming up in three weeks and one of the items on the agenda is executive compensation. A group of minority shareholders has managed to put the subject on the agenda and has submitted a proposal which, if adopted, will place severe limits on how and how much ABC executives can be paid. The proposal includes the following specifics:

Total compensation for an executive (defined as an officer of the company) must not exceed 50 times the average pay in ABC. Total compensation is defined as base pay plus short term and long-term bonuses plus the value of equity based compensation (stock options to be valued after the Black-Scholes method) plus perquisites.

Stock options, if granted, must be priced 30 % above the market price of ABC’s stock and will expire after 6 years rather than 10 years as is the case with plain vanilla options.

When exercising their options, executives are not allowed to sell their shares immediately but must hold their shares for a minimum of 4 years (“exercise and hold” rather than “exercise and sell”).

Executives can no longer receive outright stock grants.

It is known that the proposal has quite a bit of support among shareholders and just as many opponents. However, the big mutual funds and pension funds which own the majority of shares have not yet take a position. On the one hand, cases of excessive executive compensation combined with abuses such as backdating of options are a widely known fact and fund managers believe that those excesses must be curbed. Also, the proposal looks eminently reasonable, at least on the surface. On the other hand, they are worried that tying the hands of the board when deciding on executive compensation may lead to the departure of the best executives. They are thus undecided and have adopted a wait and see attitude. They will decide in the meeting whether they will vote for or against the proposal, based on the power of the arguments presented.

Observers believe the shareholders meeting will see a sharp debate and even a shouting match between the spokesperson for the minority and the CEO of the ABC Company who will argue that the minority shareholder proposal will damage the business and should be defeated.

Your paper should have two parts:

1. In part one, take the role of the spokesperson of the minority shareholders and come up with all the arguments in favor of the proposal. When doing so, discuss the four proposals one by one.

2. In part two, your role is that of the CEO’s executive assistant. You help your boss prepare for the shareholders meeting and you provide him/her with all the arguments why the proposal is detrimental to the business and should thus be defeated. Again, discuss the proposal one by one.

Submission Rules

1. No more than two pages, double spaced, are allowed.

Answer 1

Minority Shareholders V/s CEO in ABC Personal Computer Company

Agenda is to limit the executive compensation to the executive members of the company.

Arguments in favor of the proposal are:

1. Not exceed 50 times average pay in ABC: A threshold of 50 times the average pay will ensure that the profits of the company are not taken by the executive members in the name of salary and this will ensure that the main objective of wealth maximization of the shareholders of the company is achieved.
2. stock options to be valued after the Black-Scholes method: Black-Scholes method of option pricing is the most widely used valuation method of options and will ensure correct valuation of the stock options that are provided to the executives.
3. Price of a stock option must be priced 30 % above the market price of ABC’s stock as there will undue advantage granted to the executive members and they are not allotted stock options with 0 exercise price. Also, if the stock options will be exercisable in 6 years then, the profit of Market Price – Exercisable Price of stock won’t be high and the executives will hold the shares for a longer period without selling them immediately.
4. Lock – in Period of 4 years for the stock options granted to executives is very important as executives are encouraged to hold the stocks of the company, otherwise, mass selling of the stocks of the company will erode the market price of the stock.
5. Executives can no longer receive outright stock grants will ensure that executives are not getting more than what is required to pay and the stocks of the company are not concentrated in the hands of few people.

Arguments against the proposal are:

1. It is widely believed that stock options provide the best mode of motivation to the executive personnel as they work towards increasing the share price of the company to have a good profit. Restrictions on stock options might lower down their motivation to work hard.
2. Also, when stock option are priced 30 % above the market price of ABC’s stock, then there is not much profit will be available to the executive and he needs to wait for another 4 years to encash the money he has earned today.
3. Vested or stock grants should also be granted to executives as they are also considered the employees of the company.
4. These restrictions will hamper the recruiting procedure of the company as the acquisition of new talents will be difficult.
5. Eventually, the best executives of the company will leave as they are not paid fairly as the industry standards.