Question

Put yourself in the shoes of a company president: The extremely successful launch of a new product has resulted in an additional $5 million in unexpected operating cash flows. You can think of several ways to use the extra $5 million.

One alternative is to pay out a special dividend to the shareholders. As president, you are accountable to the board of directors, which is elected by the shareholders. Rather than pay a dividend, you could repurchase shares of the company's own stock. The stock seems currently to be under priced, and by purchasing treasury shares you are distributing surplus cash to shareholders without giving them taxable dividend income.You could also pay a special year-end bonus to your employees. With 500 employees, that would average $10,000 per employee, quite a nice holiday bonus. After all, it was the employees' hard work and dedication that earned the money in the first place.

Or, you could use the money to reinvest in the company. By reinvesting the money, it might be easier to continue the upward earnings trend in the future.Finally, you could approach the board of directors for a compensation adjustment of your own. It's been a great year, and you are the president of the company. Shouldn't you at least share in the success?

Determine how you would allocate the additional $5 million. Are there other areas in which to spend the money not mentioned in the above case? Is it ethical for the president to be directly compensated based on the company's performance each year?

Answer 1

Determine how you would allocate the additional $5 million. Are there other areas in which to spend the money not mentioned in the above case? Is it ethical for the president to be directly compensated based on the company's performance each year?

Answer:-

Answers regarding the allocation of the additional $5 million in operating cash flows will vary. Other areas to spend the money, not specifically mentioned in the case, include increasing employee benefits such as retirement and healthcare, investing in research and development to continue the successful launch of new products, investing in other companies to gain access to resources or technology, and giving to charity.

It is common for executives to be compensated based on the company's performance each year. This in itself is not unethical and often is a good business practice. However, when executive compensation is related to company performance, users need to be aware that this increases the risk of earnings management to meet management incentives.