Stock Holder Vs Bondholder

Amity School of Business

Theory

Practice

There is no conflict of interest Stockholder may maximize between stockholders and their wealth at the expense of bondholders bondholders: Taking riskier projects than agreed. Borrowing more on the same assets.

Firms and Financial Markets

Amity School of Business

Theory Financial markets are efficient.

Practice Managers suppress information.

Managers are honest and convey full information to financial markets. Financial markets are reasoned judgments of true value.

Managers delay the releasing of bad news.

Managers sometimes reveal fraudulent information. Some argue that markets are short sighted.

Analysts recommendations are not always unbiased.

Firms and Society

Amity School of Business

Theory

Practice

There is no costs associated Financials decisions can create with firms that can not be traced social costs and benefits where; and charged to the firms. A social costs or benefits is a cost that accrues to society as a whole not to a firm that is making a decision. These costs and benefits are difficult to quantify.

Amity School of Business

Given these agency problems, is stock maximization really the best objective? Alternate objectives: Maximize earnings. Maximize market share. Maximize firm size. Do these serve us as a better objective?

price

Maximize stock price subject to?

Amity School of Business

Maximization objective function is internal self correction mechanism. Excess on any linkages lead, if any unregulated counter actions which reduce or eliminate these excesses.

Response to Agency Problems

Amity School of Business

Bondholder Protection Restrictive covenants. New type of bond issue. More hybrid bonds. Financial Market response Regulatory changes. Increased importance of ethical behavior. Increased availability of information and ease of trade. Societal response Catering more socially conscious clientele. Growth of social responsible funds.

Amity School of Business

Management compensation and Measurement of Performance

Executive Compensation
Amity School of Business

Key elements: Salary. Benefits. Incentive Compensation.

Generated lot of debates among legislators, corporate observers, economists, journalists and management experts.

Conflict of Interest
Amity School of Business

Agency theory has examined the problem from separation of ownership from control in public co.

According to Lambert Larcker :

Principal sources of conflict: Excessive perquisites. Differential interest attitudes. Varying with time horizons.

Failure to promote value creation

Amity School of Business

Linkage between size and pay. Emphasis on short term performance. Reliance on accounting measures.

Alfred Rappaport The dysfunctional consequences introduced by the increased pay increased size philosophy and the overemphasis on the short term results are exacerbated by the universal use of accounting numbers for assessing both short and long term performance.
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Objectives for Executive compensation Amity School of Business policy

Stephen OBryne identified 4 objectives:
Alignment Managers. Strategies, action, investments, actions that maximise shareholder value. Leverage Work harder, take risk, do unpleasant things. Retention. Incentive sufficient to retain them. Shareholder cost. Level where shareholder wealth is maximised.

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Designing an Incentive Compensation Amity School of Business Plan

A well conceived incentive compensation plan goes a long way in aligning the interests of managers and shareholders. Integrate the Incentive plan into the total compensation Architecture. Choose the Appropriate Level of Risk Posture and Time Focus.

Designing an Incentive Compensation Plan

Amity School of Business

Use Objective criteria Select the right set of performance measures. Reward relative measures. Discourage parochial behavior. Abandon attempts to measure what executives control. Lengthen the Decision making Horizon of the Executives. Employ Stock Options Judiciously. Ensure tax Efficiency = Post tax benefit to manager Post tax cost to the company

ESOP
Amity School of Business

Eligibility Not a promoter, not a director who holds more than 10% of the outstanding Equity Shares. Compensation committee consisting of a majority of independent directors, for advice and supervision of the ESO scheme. No ESOS unless shareholders pass a special resolution. Pricing Lock in period and rights of the option holder.

SEBI Guidelines for ESOS

Amity School of Business

Eligibility. Compensation Committee. Shareholder Approval. Pricing. Lock in period and rights of the option holder. Accounting treatment.

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Performance Measurement
Amity School of Business

Robert W Hall:
Performance measurement is the basis of every system in a company: Cost systems. Planning systems. Capital budgeting systems. Personnel assignments. Promotions. Reorganisations. Budget allocations. - the mechanisms built up over years by which everything runs.
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Facets of business performance measurement

Amity School of Business

Rationale on current focus on performance measurement. Comprehensive value metrics framework. Non financial measures. Balance scorecard. Parta system. Performance measurement awards. Strategic performance measurement. Memorandum of understanding.

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Rationale for business performance measurement Amity School of Business

Heightened competition. Growing empowerment. Quality awards. Expanding organisational roles. Greater external demands. Power of information technology.

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Comprehensive value risk framework

Amity School of Business

Total shareholder return (TSR).

Market value added (MVA).

Discounted cash flows (DCF).

Economic value added (EVA).

Economic Profit.

Cash flow return on investment (CFROI).

Cash value added (CVA).

Return on invested capital (ROIC).

Return on Assets (ROA).

Earnings before interest taxes depreciation and amortisation (EBITA).

Cash flow.

Earning per share (EPS).

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Non Financial Measures

Amity School of Business
Customer Satisfaction Index Customer Return Market share New product Introduction On time Delivery Manufacturing cycle time Defects Percentage Throughput Employee Productivity Index Patents Obtained

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Strengths and weaknesses- Non Financial Measures

Amity School of Business

Strengths Directly traceable to key success factors: Customer satisfaction, market leadership, manufacturing excellence, Quality etc. Actionable. Predict better picture of cashflows. Weaknesses Difficult to assign rupee value to improvements in non financial measures. Conflict with each other. Managers may resort to gaming.
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