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1. Who is the CFO? Where does this individual fit in the corporate hierarchy? What are his or her responsibilities in an organization? MINIMUM ONE & HALF PAGE REQUIREMENT. Chapter # 1.2. Why are Financial Markets essential for a Healthy economy and Economic growth? MINIMUM ONE PAGE REQUIREMENT. Chapter # 2.3. Explore the 10K or 10Q report of any public company of your choice and Write minimum ONE page as to what info you found in this report. You can explore any report of year 2022. Let me know what public company you are choosing by emailing me.4. Explore the website Marketwatch.com and write TWO pages as to what info you found on the website. Explore different tabs.REFERENCES ARE MANDATORY.Below are 2 files chapter 1 and chapter 2 for questions 1 and 2APA format, Use the APA template located in the Student Resource Center to complete the assignment.
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Introduction
Striking the Right Balance
In 1776, Adam Smith described how an “invisible hand” guides companies as they strive for
profits, and that hand leads them to decisions that benefit society. Smith’s insights led him
to conclude that profit maximization is the right goal for a business and that the free
enterprise system is best for society. But the world has changed since 1776. Firms today are
much larger, they operate globally, they have thousands of employees, and they are owned
by millions of stockholders. This makes us wonder if the “invisible hand” still provides
reliable guidance: Should companies still try to maximize profits, or should they take a
broader view and more balanced actions designed to benefit customers, employees,
suppliers, and society as a whole?
Many academics and finance professionals today subscribe to the following modified version
of Adam Smith’s theory:
A firm’s principal financial goal should be to maximize the wealth of its stockholders, which
means maximizing the value of its stock.
Free enterprise is still the best economic system for society as a whole. Under the free
enterprise framework, companies develop products and services that people want and that
benefit society.
However, some constraints are needed—firms should not be allowed to pollute the air and
water, to engage in unfair employment practices, or to create monopolies that exploit
consumers.
These constraints take a number of different forms. The first set of constraints is the costs
that are assessed on companies if they take actions that harm society. Another set of
constraints arises through the political process, where society imposes a wide range of
regulations that are designed to keep companies from engaging in harmful practices.
Properly imposed, these costs fairly transfer value to suffering parties and help create
incentives that help prevent similar events from occurring in the future.
The financial crisis in 2007 and 2008 dramatically illustrates these points. We witnessed
many Wall Street firms engaging in extremely risky activities that pushed the financial
system to the brink of collapse. Saving the financial system required a bailout of the banks
and other financial companies, and that bailout imposed huge costs on taxpayers and
helped push the economy into a deep recession. Apart from the huge costs imposed on
society, the financial firms also paid a heavy price—a number of leading financial institutions
saw a huge drop in their stock price, some failed and went out of business, and many Wall
Street executives lost their jobs.
Arguably, these costs are not enough to prevent another financial crisis from occurring.
Many maintain that the events surrounding the financial crisis illustrate that markets don’t
always work the way they should and that there is a need for stronger regulation of the
financial sector. For example, in his recent books, Nobel Laureate Joseph Stiglitz makes a
strong case for enhanced regulation. At the same time, others with a different political
persuasion continue to express concerns about the costs of excessive regulation.
Beyond the financial crisis, there is a broader question of whether laws and regulations are
enough to compel firms to act in society’s interest. An increasing number of companies
continue to recognize the need to maximize shareholder value, but they also see their
mission as more than just making money for shareholders. Google’s parent company
Alphabet’s motto is “Do the right thing—follow the law, act honorably, and treat each other
with respect.” Consistent with this mission, the company has its own in-house foundation
that each year makes large investments in a wide range of philanthropic ventures
worldwide.
Microsoft is another good example of a company that has earned a reputation for taking
steps to be socially responsible. The company recently released its 2019 Corporate Social
Responsibility Report. In an accompanying letter to shareholders, Microsoft CEO Satya
Nadella highlighted its broader mission:
Our mission to empower every person and every organization on the planet to achieve more
has never been more important. At a time when many are calling attention to the role
technology plays in society broadly, our mission remains constant. It grounds us in the
enormous opportunity and responsibility we have to ensure that the technology we create
always benefits everyone on the planet, including the planet itself. Our platforms and tools
help make small businesses more productive, multinationals more competitive, nonprofits
more effective, and governments more efficient. They improve healthcare and education
outcomes, amplify human ingenuity, and allow people everywhere to reach higher.
Similarly, the Business Roundtable, a group of leading business executives, made news in
2019 when it put out a statement indicating that companies should explicitly account for the
broader interests of stakeholders, not just focus exclusively on shareholders.
While many companies and individuals have taken very significant steps to demonstrate
their commitments to being socially responsible, corporate managers frequently face a
tough balancing act. Realistically, there will still be cases where companies face conflicts
between their various constituencies—for example, a company may enhance shareholder
value by laying off some workers, or a change in policy may improve the environment but
reduce shareholder value. We also have seen examples where leading tech companies such
as Facebook and Google have come under fire for their handling of their users’ private
information. In each of these instances, managers have to balance these competing interests
and different managers will clearly make different choices. More recently, virtually every
organization has faced considerable pressure trying to manage their various constituencies
in the midst of the massive personal and economic dislocation resulting from the
coronavirus pandemic. At the end of the day, all companies struggle to find the right
balance. Enlightened managers recognize that there is more to life than money, but it often
takes money to do good things.
Sources: “Microsoft 2019 Corporate Social Responsibility Report,” microsoft.com/enus/corporate-responsibility/reports-hub, October 16, 2019; “Microsoft 2019 Annual Report,”
microsoft.com/investor/reports/ar19/index.html, October 16, 2019; “Business Roundtable
Redefines the Purpose of a Corporation to Promote ‘An Economy That Serves All
Americans,’” businessroundtable.org/business-roundtable-redefines-the-purpose-of-acorporation-to-promote-an-economy-that-serves-all-americans, August 19, 2019; Kevin J.
Delaney, “Google: From ‘Don’t Be Evil’ to How to Do Good,” The Wall Street Journal, January
18, 2008, pp. B1–B2; Joseph E. Stiglitz, FreeFall: America, Free Markets, and the Sinking of
the World Economy (New York: W.W. Norton, 2010); and Joseph E. Stiglitz, The Price of
Inequality (New York: W.W. Norton, 2012).
Putting Things in Perspective
This chapter will give you an idea of what financial management is all about. We begin the
chapter by describing how finance is related to the overall business environment, by
pointing out that finance prepares students for jobs in different fields of business, and by
discussing the different forms of business organization. For corporations, management’s goal
should be to maximize shareholder wealth, which means maximizing the value of the stock.
When we say “maximizing the value of the stock,” we mean the “true, long-run value,”
which may be different from the current stock price. In the chapter, we discuss how firms
must provide the right incentives for managers to focus on long-run value maximization.
Good managers understand the importance of ethics, and they recognize that maximizing
long-run value is consistent with being socially responsible.
When you finish this chapter, you should be able to do the following:
Explain the role of finance and the different types of jobs in finance.
Identify the advantages and disadvantages of different forms of business organization.
Explain the links between stock price, intrinsic value, and executive compensation.
Identify the potential conflicts that arise within the firm between stockholders and
managers and between stockholders and bondholders, and discuss the techniques that firms
can use to mitigate these potential conflicts.
Discuss the importance of business ethics and the consequences of unethical behavior.
1-1. What Is Finance?
Finance is defined by Webster’s Dictionary as “the system that includes the circulation of
money, the granting of credit, the making of investments, and the provision of banking
facilities.” Finance has many facets, which makes it difficult to provide one concise definition.
The discussion in this section will give you an idea of what finance professionals do and what
you might do if you enter the finance field after you graduate.
1-1A. Areas of Finance
Finance as taught in universities is generally divided into three areas:
(1)
financial management,
(2)
capital markets, and
(3)
investments.
Financial management, also called corporate finance, focuses on decisions relating to how
much and what types of assets to acquire, how to raise the capital needed to purchase
assets, and how to run the firm so as to maximize its value. The same principles apply to
both for-profit and not-for-profit organizations, and as the title suggests, much of this book
is concerned with financial management.
Capital markets relate to the markets where interest rates, along with stock and bond prices,
are determined. Also studied here are the financial institutions that supply capital to
businesses. Banks, investment banks, stockbrokers, mutual funds, insurance companies, and
the like bring together “savers” who have money to invest and businesses, individuals, and
other entities that need capital for various purposes. Governmental organizations such as
the Federal Reserve System, which regulates banks and controls the supply of money, and
the Securities and Exchange Commission (SEC), which regulates the trading of stocks and
bonds in public markets, are also studied as part of capital markets.
Investments relate to decisions concerning stocks and bonds and include a number of
activities:
(1)
Security analysis deals with finding the proper values of individual securities (i.e., stocks and
bonds).
(2)
Portfolio theory deals with the best way to structure portfolios, or “baskets,” of stocks and
bonds. Rational investors want to hold diversified portfolios in order to limit risks, so
choosing a properly balanced portfolio is an important issue for any investor.
(3)
Market analysis deals with the issue of whether stock and bond markets at any given time
are “too high,” “too low,” or “about right.”
Included in market analysis is behavioral finance, where investor psychology is examined in
an effort to determine whether stock prices have been bid up to unreasonable heights in a
speculative bubble or driven down to unreasonable lows in a fit of irrational pessimism.
Although we separate these three areas, they are closely interconnected. Banking is studied
under capital markets, but a bank lending officer evaluating a business’ loan request must
understand corporate finance to make a sound decision. Similarly, a corporate treasurer
negotiating with a banker must understand banking if the treasurer is to borrow on
“reasonable” terms. Moreover, a security analyst trying to determine a stock’s true value
must understand corporate finance and capital markets to do his or her job. In addition,
financial decisions of all types depend on the level of interest rates; so all people in
corporate finance, investments, and banking must know something about interest rates and
the way they are determined. Because of these interdependencies, we cover all three areas
in this book.
1-1B. Finance within an Organization
The duties of the CFO have broadened over the years. CFO magazine’s online service,
cfo.com, is an excellent source of timely finance articles intended to help the CFO manage
those new responsibilities.
Most businesses and not-for-profit organizations have an organization chart similar to the
one shown in Figure 1.1. The board of directors is the top governing body, and the
chairperson of the board is generally the highest-ranking individual. The chief executive
officer (CEO) comes next, but note that the chairperson of the board often also serves as the
CEO. Below the CEO comes the chief operating officer (COO), who is often also designated as
a firm’s president. The COO directs the firm’s operations, which include marketing,
manufacturing, sales, and other operating departments. The chief financial officer (CFO),
who is generally a senior vice president and the third-ranking officer, is in charge of
accounting, finance, credit policy, decisions regarding asset acquisitions, and investor
relations, which involves communications with stockholders and the press.
Figure 1.1 Finance within the Organization
Details
If the firm is publicly owned, the CEO and the CFO must both certify to the SEC that reports
released to stockholders, and especially the annual report, are accurate. If inaccuracies later
emerge, the CEO and the CFO could be fined or even jailed. This requirement was instituted
in 2002 as a part of the Sarbanes-Oxley Act. The act was passed by Congress in the wake of a
series of corporate scandals involving now-defunct companies such as Enron and WorldCom,
where investors, workers, and suppliers lost billions of dollars due to false information
released by those companies.
1-1C. Finance versus Economics and Accounting
Finance, as we know it today, grew out of economics and accounting. Economists developed
the notion that an asset’s value is based on the future cash flows the asset will provide, and
accountants provided information regarding the likely size of those cash flows. People who
work in finance need knowledge of both economics and accounting. Figure 1.1 illustrates
that in the modern corporation, the accounting department typically falls under the control
of the CFO. This further illustrates the link among finance, economics, and accounting.
SelfTest
What three areas of finance does this book cover? Are these areas independent of one
another, or are they interrelated in the sense that someone working in one area should
know something about each of the other areas? Explain.
Who is the CFO, and where does this individual fit into the corporate hierarchy? What are
some of his or her responsibilities?
Does it make sense for not-for-profit organizations such as hospitals and universities to have
CFOs? Why or why not?
What is the relationship among economics, finance, and accounting?
1-2. Jobs in Finance
To find information about different finance careers, go to allbusinessschools.com/businesscareers/finance/job-description. This website provides information about different finance
areas.
Finance prepares students for jobs in banking, investments, insurance, corporations, and
government. Accounting students need to know marketing, management, and human
resources; they also need to understand finance, for it affects decisions in all those areas.
For example, marketing people propose advertising programs, but those programs are
examined by finance people to judge the effects of the advertising on the firm’s profitability.
So to be effective in marketing, one needs to have a basic knowledge of finance. The same
holds for management—indeed, most important management decisions are evaluated in
terms of their effects on the firm’s value.
It is also worth noting that finance is important to individuals regardless of their jobs. Some
years ago most employees received pensions from their employers upon retirement, so
managing one’s personal investments was not critically important. That’s no longer true.
Most firms today provide “defined contribution” pension plans, where each year the
company puts a specified amount of money into an account that belongs to the employee.
The employee must decide how those funds are to be invested—how much should be
divided among stocks, bonds, or money funds—and how much risk they’re willing to take
with their stock and bond investments. These decisions have a major effect on people’s lives,
and the concepts covered in this book can improve decision-making skills.
1-3. Forms of Business Organization
efinancialcareers.com provides finance career news and advice including information on
who’s hiring in finance and accounting fields.
The basics of financial management are the same for all businesses, large or small,
regardless of how they are organized. Still, a firm’s legal structure affects its operations and
thus should be recognized. There are four main forms of business organizations:
(1)
proprietorships,
(2)
partnerships,
(3)
corporations, and
(4)
limited liability companies (LLCs) and limited liability partnerships (LLPs).
In terms of numbers, most businesses are proprietorships. However, based on the dollar
value of sales, more than 80% of all business is done by corporations. Because corporations
conduct the most business and because most successful businesses eventually convert to
corporations, we focus on them in this book. Still, it is important to understand the legal
differences between types of firms.
A proprietorship is an unincorporated business owned by one individual. Going into business
as a sole proprietor is easy—a person begins business operations. Proprietorships have three
important advantages:
(1)
They are easy and inexpensive to form,
(2)
they are subject to few government regulations, and
(3)
they are subject to lower income taxes than are corporations.
However, proprietorships also have three important limitations:
(1)
Proprietors have unlimited personal liability for the business’ debts, so they can lose more
than the amount of money they invested in the company. You might invest $10,000 to start a
business but be sued for
$
1
million
if, during company time, one of your employees runs over someone with a car.
(2)
The life of the business is limited to the life of the individual who created it, and to bring in
new equity, investors require a change in the structure of the business.
(3)
Because of the first two points, proprietorships have difficulty obtaining large sums of
capital; hence, proprietorships are used primarily for small businesses.
However, businesses are frequently started as proprietorships and then converted to
corporations when their growth results in the disadvantages outweighing the advantages.
A partnership is a legal arrangement between two or more people who decide to do
business together. Partnerships are similar to proprietorships in that they can be established
relatively easily and inexpensively. Moreover, the firm’s income is allocated on a pro rata
basis to the partners and is taxed on an individual basis. This allows the firm to avoid the
corporate income tax. However, all of the partners are generally subject to unlimited
personal liability, which means that if a partnership goes bankrupt and any partner is unable
to meet his or her pro rata share of the firm’s liabilities, the remaining partners will be
responsible for making good on the unsatisfied claims. Thus, the actions of a Texas partner
can bring ruin to a millionaire New York partner who had nothing to do with the actions that
led to the downfall of the company. Unlimited liability makes it difficult for partnerships to
raise large amounts of capital.
A corporation is a legal entity created by a state, and it is separate and distinct from its
owners and managers. It is this separation that limits stockholders’ losses to the amount
they invested in the firm—the corporation can lose all of its money, but its owners can lose
only the funds that they invested in the company. Corporations also have unlimited lives,
and it is easier to transfer shares of stock in a corporation than one’s interest in an
unincorporated business. These factors make it much easier for corporations to raise the
capital necessary to operate large businesses. Thus, companies such as Hewlett-Packard and
Microsoft generally begin as proprietorships or partnerships, but at some point they find it
advantageous to become a corporation.
A major drawback to corporations is taxes. Most corporations’ earnings are subject to
double taxation—the corporation’s earnings are taxed, and then when its after-tax earnings
are paid out as dividends, those earnings are taxed again as personal income to the
stockholders. However, as an aid to small businesses, Congress created S Corporations,
which are taxed as if they were proprietorships or partnerships; thus, they are exempt from
the corporate income tax. To qualify for S corporation status, a firm can have no more than
100 stockholders, which limits their use to relatively small, privately owned firms. Larger
corporations are known as C corporations. The vast majority of small corporations elect S
status and retain that status until they decide to sell stock to the public, at which time they
become C corporations.
A limited liability company (LLC) is a popular type of organization that is a hybrid between a
partnership and a corporation. A limited liability partnership (LLP) is similar to an LLC. LLPs
are used for professional firms in the fields of accounting, law, and architecture, while LLCs
are used by other businesses. Similar to corporations, LLCs and LLPs provide limited liability
protection, but they are taxed as partnerships. Further, unlike limited partnerships, where
the general partner has full control of the business, the investors in an LLC or LLP have votes
in proportion to their ownership interest. LLCs and LLPs have been gaining in popularity in
recent years, but large companies still find it advantageous to be C corporations because of
the advantages in raising capital to support growth. LLCs/LLPs were dreamed up by lawyers;
they are often structured in very complicated ways, and their legal protections often vary by
state. So it is necessary to hire a good lawyer when establishing one.
When deciding on its form of organization, a firm must trade off the advantages of
incorporation against double taxation. However, for the following reasons, the value of any
business other than a relatively small one will probably be maximized if it is organized as a
corporation:
Limited liability reduces the risks borne by investors, and, other things held constant, the
lower the firm’s risk, the higher its value.
A firm’s value is dependent on its growth opportunities, which are dependent on its ability
to attract capital. Because corporations can attract capital more easily than other types of
businesses, they are better able to take advantage of growth opportunities.
The value of an asset also depends on its liquidity, which means the time and effort it takes
to sell the asset for cash at a fair market value. Because the stock of a corporation is easier
to transfer to a potential buyer than is an interest in a proprietorship or partnership and
because more investors are willing to invest in stocks than in partnerships (with their
potential unlimited liability), a corporate investment is relatively liquid. This too enhances
the value of a corporation.
SelfTest
What are the key differences among proprietorships, partnerships, and corporations?
How are LLCs and LLPs related to the other forms of organization?
What is an S corporation, and what is its advantage over a C corporation? Why don’t firms
such as IBM, GE, and Microsoft choose S corporation status?
What are some reasons why the value of a business other than a small one is generally
maximized when it is organized as a corporation?
1-4. The Main Financial Goal: Creating Value for Investors
In public corporations, managers and employees work on behalf of the shareholders who
own the business, and therefore they have an obligation to pursue policies that promote
stockholder value. While many companies focus on maximizing a broad range of financial
objectives, such as growth, earnings per share, and market share, these goals should not
take precedence over the main financial goal, which is to create value for investors. Keep in
mind that a company’s stockholders are not just an abstract group—they represent
individuals and organizations who have chosen to invest their hard-earned cash into the
company and who are looking for a return on their investment in order to meet their longterm financial goals, which might be saving for retirement, a new home, or a child’s
education. In addition to financial goals, the firm also has nonfinancial goals, which we will
discuss in Section 1-7.
If a manager is to maximize stockholder wealth, he or she must know how that wealth is
determined. Throughout this book, we shall see that the value of any asset is the present
value of the stream of cash flows that the asset provides to its owners over time. We discuss
stock valuation in depth in Chapter 9, where we see that stock prices are based on cash
flows expected in future years, not just in the current year. Thus, stock price maximization
requires us to take a long-run view of operations. At the same time, managerial actions that
affect a company’s value may not immediately be reflected in the company’s stock price.
1-4A. Determinants of Value
Figure 1.2 illustrates the situation. The top box indicates that managerial actions, combined
with the economy, taxes, and political conditions, influence the level and riskiness of the
company’s future cash flows, which ultimately determine the company’s stock price. As you
might expect, investors like higher expected cash flows, but they dislike risk; so the larger the
expected cash flows and the lower the perceived risk, the higher the stock’s price.
Figure 1.2 Determinants of Intrinsic Values and Stock Prices
Details
The second row of boxes differentiates what we call “true” expected cash flows and “true”
risk from “perceived” cash flows and “perceived” risk. By “true,” we mean the cash flows
and risk that investors would expect if they had all of the information that existed about a
company. “Perceived” means what investors expect, given the limited information they have.
To illustrate, in early 2001, investors had information that caused them to think Enron was
highly profitable and would enjoy high and rising future profits. They also thought that
actual results would be close to the expected levels and hence that Enron’s risk was low.
However, true estimates of Enron’s profits, which were known by its executives but not the
investing public, were much lower; Enron’s true situation was extremely risky.
The third row of boxes shows that each stock has an intrinsic value, which is an estimate of
the stock’s “true” value as calculated by a competent analyst who has the best available
data, and a market price, which is the actual market price based on perceived but possibly
incorrect information as seen by the marginal investor. Not all investors agree, so it is the
“marginal” investor who determines the actual price.
When a stock’s actual market price is equal to its intrinsic value, the stock is in equilibrium,
which is shown in the bottom box in Figure 1.2. When equilibrium exists, there is no
pressure for a change in the stock’s price. Market prices can—and do—differ from intrinsic
values; eventually, however, as the future unfolds, the two values tend to converge.
1-4B. Intrinsic Value
Actual stock prices are easy to determine—they can be found on the Internet and are
published in newspapers every day. However, intrinsic values are estimates, and different
analysts with different data and different views about the future form different estimates of
a stock’s intrinsic value. Indeed, estimating intrinsic values is what security analysis is all
about and is what distinguishes successful from unsuccessful investors. Investing would be
easy, profitable, and essentially riskless if we knew all stocks’ intrinsic values—but, of course,
we don’t. We can estimate intrinsic values, but we can’t be sure that we are right. A firm’s
managers have the best information about the firm’s future prospects, so managers’
estimates of intrinsic values are generally better than those of outside investors. However,
even managers can be wrong.
Figure 1.3 graphs a hypothetical company’s actual price and intrinsic value as estimated by
its management over time. The intrinsic value rises because the firm retains and reinvests
earnings each year, which tends to increase profits. The value jumped dramatically in Year
20, when a research and development (R&D) breakthrough raised management’s estimate
of future profits before investors had this information. The actual stock price tended to
move up and down with the estimated intrinsic value, but investor optimism and pessimism,
along with imperfect knowledge about the true intrinsic value, led to deviations between
the actual prices and intrinsic values.
Figure 1.3 Graph of Actual Prices versus Intrinsic Values
Details
Intrinsic value is a long-run concept. Management’s goal should be to take actions designed
to maximize the firm’s intrinsic value, not its current market price. Note, though, that
maximizing the intrinsic value will maximize the average price over the long run but not
necessarily the current price at each point in time. For example, management might make
an investment that lowers profits for the current year but raises expected future profits. If
investors are not aware of the true situation, the stock price will be held down by the low
current profit even though the intrinsic value was actually raised. Management should
provide information that helps investors make better estimates of the firm’s intrinsic value,
which will keep the stock price closer to its equilibrium level. However, there are times when
management cannot divulge the true situation because doing so would provide information
that helps its competitors.
1-4C. Consequences of Having a Short-Run Focus
Ideally, managers adhere to this long-run focus, but there are numerous examples in recent
years where the focus for many companies shifted to the short run. Perhaps most notably,
prior to the recent financial crisis, many Wall Street executives received huge bonuses for
engaging in risky transactions that generated short-term profits. Subsequently, the value of
these transactions collapsed, causing many of these Wall Street firms to seek a massive
government bailout.
Apart from the recent problems on Wall Street, there have been other examples where
managers have focused on short-run profits to the detriment of long-term value. For
example, Wells Fargo implemented incentives to reward employees for signing up customers
to new accounts. Unfortunately, to obtain bonuses some employees created fake accounts
or signed up customers for unauthorized credit cards. This led to the firing of thousands of
employees, as well as its CEO and other senior managers, and millions of dollars in fines for
Wells Fargo. In addition, the Fed has limited Wells Fargo’s growth so total assets are no
greater than the year end 2017 total until the bank repairs its culture and cleans up its act.
On February 21, 2020, Wells Fargo agreed to pay $3 billion to settle claims, including
$
500
million
that will be returned to investors. Wells Fargo has eliminated all product-based sales goals,
restructured its compensation, and strengthened customer consent and oversight systems.
With these types of concerns in mind, many academics and practitioners stress the need for
boards and directors to establish effective procedures for corporate governance. This
involves putting in place a set of rules and practices to ensure that managers act in
shareholders’ interests while also balancing the needs of other key constituencies such as
customers, employees, and affected citizens. Having a strong, independent board of
directors is viewed as an important component of strong governance.
Effective governance requires holding managers accountable for poor performance and
understanding the important role that executive compensation plays in encouraging
managers to focus on the proper objectives. For example, if a manager’s bonus is tied solely
to this year’s earnings, it would not be a surprise to discover that the manager took steps to
pump up current earnings—even if those steps were detrimental to the firm’s long-run
value. With these concerns in mind, a growing number of companies have used stock and
stock options as a key part of executive pay. The intent of structuring
