INSTRUCTOR DISCUSSION NOTES:
Executive Options Are Like Medicine: We May not Like Them, but They're Usually Good for Us

1. Does the practice of backdating stock options violate the incentive compatibility constraint of a principal/agent model, or the participation constraint? Why?

Incentive compatibility, because it doesn't ensure high effort.

2. Part of the article suggested that the practice has become one of "everybody does it." Does that make backdating stock options a prisoner's dilemma solution? Why or why not?

Possibly, because it's not something a firm wants to do, but can't afford not to do it if its competitors provide their managers with this dubious "tool."

3. Does the fact that such backdating of options is considered illegal under Sarbanes-Oxley guarantee a reduction in its usage?

Not necessarily; it at least increases the cost of backdating, assuming that the law is enforced. If the law isn't enforced, then it won't be considered "incentive-compatible."

Multiple Choice/True False Questions

1. True/False. In a model of principal and agent, the corporate executive would be the agent to the shareholder's principal.

ANS . True

2. An example of an incentive compatibility constraint in a principal/agent model such as the one described in the article would be:
  1. High salary.
  2. Equity-based compensation.
  3. Use of corporate jet.
  4. Private car.
ANS . b

3. An example of a participation constraint of the principal/agent model such as the one described in the article would be

  1. High salary.
  2. Equity-based compensation.
  3. Use of corporate jet.
  4. A and C.
ANS . d

©2007  South-Western.  All Rights Reserved   webmaster  |   DISCLAIMER