Essay on Week 12 Assignment Chingos 10 11

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Week 12 Homework Assignment -- Chingos 10、11
Yuanjun Zhang (IRIS)

1、What are the two primary objectives of any Long Term Incentive? What three forms of awards do Long Term Incentive arrangements take? According to the author which one is the most prevalent?

Two primary objectives
Long-term incentives create an identity between the interests of executives and shareholders.
Long-term incentives also encourage stock ownership.

Three forms of awards
• Capital stock or the right to purchase or receive capital stock under specified terms and conditions
• The right to receive cash under specified terms and conditions
• A combination of any of the foregoing

Stock options, restricted stock, and performance awards consisting of shares, units, or cash figure as the primary forms of long-term incentive and capital accumulation plans. Other approaches, such as phantom stock, are far less prevalent.

2、What is restricted stock? Define “stock option.”Briefly explain what is meant by “stock appreciation rights.” when is it effectively used?

Restricted stock involves an outright award of shares to the executive. Normally the executive does not pay for the shares, although in some states and in certain mutual organizations, a nominal consideration, often the par value of the shares, is required. The executive enjoys the rights of a shareholder immediately, including voting and dividend rights, except that the right to sell or transfer the shares is restricted for a fixed period. If the executive leaves the employ of the company during this restricted period, the shares are forfeited, making restricted stock an effective retention device.

A grant of stock options provides the optionee with the right to purchase a given number of shares of common stock at a fixed price for a defined term, usually 10 years. The option exercise price, or strike price, is normally set equal to the fair market value of a share on the date of grant, but may be set above fair market value (“premium-priced options”) or below fair market value (“discounted options”). Today most companies use stock options priced “at the money” as their core capital accumulation plan.

A stock appreciation right (SAR) provides the executive with the right to receive a payment equal to the appreciation in the fair market value of a given number of shares for a fixed period, normally 10 years.

From the executive’s perspective, exercising nonqualified options is comparable to exercising SARs. The key difference is that the executive actually makes a purchase when exercising an option, receives shares, and has the opportunity to maintain an investment in the company by holding the shares. When an SAR is exercised for cash, a transfer of shares does not occur. While options and SARs have reasonably similar financial consequences for the executive, the financial impact on the company differs markedly. Unlike options, SARs result in a charge to earnings equal to the appreciation embedded in the underlying shares.
SARs were used extensively as an alternative to stock options until the Securities Exchange Commission (SEC) revamped the insider trading rules under Section 16 of the 1934 Securities Act in the early 1990s.

Under the simplified insider trading rules, corporate insiders were allowed to exercise options and sell the shares acquired immediately, provided the stock option was held for at least six months after grant and certain other conditions related to the option plan itself were met. The need for SARs disappeared, and most companies stopped granting them to avoid the onerous accounting and cash flow implications.

3、What is meant by overhang? Why is it an investor concern for publicly traded companies? What is the relation between market volatility and equity based long-term incentive programs?

Overhang is a measure of the potential dilution to which a common stock's existing shareholders are exposed due to the potential that stock-based compensation will be