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 K300,000 should the company share price have increased by more than 18% at the end of the next 6 months. In addition, the managers will be entitled to 6,000 free shares each, should the share price have increased by more than 12% at the end of the next 6 months. You are given the following data: Current share price K94.50 Continuously-compounded risk-free rate 4% pa Share price volatility 22% 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 modi cations to the scheme that will ensure that the managers' aims coincide with the long-term objectives of the shareholders.
1. (a) 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
K300,000 should the company share price have increased by more than 18% at the end of the next 6 months. In addition, the managers will be entitled to 6,000 free shares each, should the share price have increased by more than 12% at the end of the next 6 months. You are given the following data:
Current share price K94.50
Continuously-compounded risk-free rate 4% pa
Share price volatility 22% 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 modi cations to the scheme that will ensure that the managers'
aims coincide with the long-term objectives of the shareholders.
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