President's Compensation Program Recommendation

You presented an inquiry as to whether or not it would be best to change our current CEO/President’s compensation program from the current salary stock option plan to equity share performance. After reading Martin Pretty’s recent article, “Where dividends top pay, CEOs tend to outperform,” in the October 17, 2012 issue of The Sydney Morning Herald, here is my evaluation of the pros and cons of changing our current CEO/President’s compensation program.

Before I begin my evaluation, let me clarify the purpose of a firm’s management. Management’s main objective is to make decisions that will maximize the value of the firm. When the stock is traded, as it is for our Fortune 500 Company, the objective is accomplished by maximizing the stock price. The article stated that, “it seems a most natural concept to expect that executives and boards with ''skin in the game'' are better aligned with external shareholders.” Given this stance, below is a key point that we should consider when evaluating whether the compensation program for the current salary stock option should be replaced by an equity share performance program:

• More equity indirectly forces management to align their goals with shareholders. In other words, giving management direct equity gives them incentive to increase the value of the firm by making decisions to increase the firm’s stock price.

Despite this large benefit to shareholders, it is important that we consider the long-term ramifications of this change in the compensation program:

• Management has an incentive to consider short-term growth instead of long-term stability. Since their compensation is tied to equity, they may take on investments that will help the company acquire short-term gains at the expense of long-term losses.

• Management may lose the firm’s ability to receive loans in the future. Their