Discuss the importance and limitations of Executive Share Option Plans (ESOPs) in mitigating management/shareholder agency conflicts

Advanced Financial Management Block Revision Mock Exams

 Importance and limitations of executive share option plans (ESOP‟s)

Goal congruence refers to the situations where the goals of different groups coincide. In many companies there are potential conflicts of objectives between the owners of the company, the shareholders, agents and the managers of the company. Other interest groups such as creditors, the government, employees and the local community might also have conflicting objectives to the company‟s shareholders.

One way which managers and sometimes employees in general might be motivated to take decision/engage in actions which are consistent with the goals of the shareholders is through ESOP‟s. ESOP‟s will not however assist in encouraging goal congruence between
other interest groups and shareholders and managers.

ESOP‟s allow managers to purchase a company‟s shares at a fixed price during a specified period of time in the future usually a period of years. They are aimed at encouraging managers to take decisions which will result in high NPV projects which will lead to an increase in share price and shareholders wealth. The managers are believed to seek high NPV investments as they as shareholders will participate in the benefits as share prices increases.

There is however little evidence of a positive correlation between share option schemes and the creation of extra share value. There is no guarantee that ESOP‟s will achieve goal congruence. Share options will only be part of the total remuneration package and may not be the major influence on managerial decisions. If share prices fall managers do not have to purchase the shares and the value of the option to buy shares becomes worthless or very small. Although ESOPs may assist in the achievement of goal congruence they are no means a perfect solution.

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