Question

QUESTION 2 A company’s directors have decided to provide senior managers with a performance bonus scheme. The bonus scheme entitles the managers to a cash payment of K250,000 should the company share price have increased by more than 20% at the end of the next 6 months. In addition, the managers will be entitled to 5,000 free shares each, should the share price have increased by more than 10% at the end of the next 6 months. You are given the following data: Current share price K78.10 Continuously-compounded risk-free rate 5% pa Share price volatility 25% pa No dividends to be paid over the next 6 months.

(i) Explain three disadvantages of this bonus scheme as an incentive for managers to perform.

(ii) Some shareholders are concerned that this scheme might cause an undesirable distortion to the managers’ behaviour. Suggest three modifications to the scheme that will ensure that the managers’ aims coincide with the long-term objectives of the shareholders

Answer 1

1.Disadvntages of presnt bonous scheeme :

Bonus scheme should be given by consisdering the both financial and non financial conditions.

Individual may take a short term view of performance to achive the target by igoring the long term effect.

setting an apporiprate target may be difficult may be difficult .

Individual will focous on what is being measured and ignored on non measure aspects as it may leads to tunnal vision.

2.Modification for the scheeme that ensures the managers aims to coninside the long term objective of shareholders:

It shoild offer a real incentives the potential rewards should be sufficent to motivate the managers

A wel desined reward scheme should shap the behavior of the manager in a way that it is consistant with the achiving the long term business objective and meeting the nned of share holders.

Scheme should include the better pay to manager to take the long term view.

The shoild be updated every day it may leads to continous improvements.

The above points to be consisdered to improve the performance that can aim for long term bulding.