Incentive Effects Of Stock Purchase Plans - Case Study Example

? Article Incentive effects of stock purchase plans: This article was written by Sanjai Bhagat. Financial economists are interested in various compensation plans. They are mostly keen to know if there are any alternate compensation plans available for tax, incentive and signaling reasons. Most compensation plans have tax implications which makes it difficult to figure out and evaluate the overall effects of using these plans. This was a comprehensive research on the stock market reach reaction to various employee stock purchase plans. The plans are mostly non-tax advantageous and adopted for signaling reasons. The study proved that equity-based compensation plans tend to have a more positive impact on shareholder wealth; one of the primary reasons behind adopted these compensation schemes is to ensure that managerial and shareholder interests are in sync and equity ownership boosts key execuctives more than sub ordinate employees. Smitt and Watt claimed in this study that equity based compensation schemes will trigger top employees more than the lower level employees. The hypothesis is proved using identified plans in the study. The stock purchase plans that were meant were key executives guaranteed greater returns compared to other adjusted returns. The result thus vaguely support the Smith-Watts suggestion. For instance, the IRS 423 plan which was meant for the employees within the organization gave a zero reaction on the announcement date. Article 2: The impact of Long range Managerial Plans on Shareholder wealth by James A Brickley Economists have often voiced out the economic importance of different types of managerial compensation schemes. However there are certain groups, for instance shareholder advocate groups who are against managerial compensation contracts. These groups insist that some plans are advantageous for managers at the expense of other shareholders. This means that while they may prove worthy for managers, they put the interest of shareholders at stake. Moreover, very little research has been conducted on this subject. There is insufficient literature out there to draw inferences from as well. The effect of various managerial plans on shareholder wealth is an empirically important issue. This study attempts to look into this issue more comprehensively and empircally. This study throws insight on the stock price reaction when there was on announcement regarding changes in long term managerial compensation packages. It is a comprehensive study undertaken by James A Brickley. The study presented evidences proving that most change plans are welcomed with positive market reaction. This is because at the end of the day, they increase shareholder wealth. The study is unable to mark comparisons between different types of market reactions to different types of compensation schemes. The difference could not be nailed in this study. The result supports the nation that every firm has it’s own set of managerial compensation requirement and every firm treats it different. Thus, there is no compensation package that is better than the other one. The profitability and feasibility of every compensation plan depends on the organization. A cross sectional analysis was done to prove the afforementioned notion. Article 3: The Modigilani Millar Propositions after 30 years by Merton H. Miller This article was published in the Journal of Economic Perspective. The journal was published on the 30th anniversary of the Modigilan-Millar propositions regarding the cost of capital, finance and the theory of investment. The article was published in the American Economic Review of June 1958. This article throws insight into the kind of significance these propositions hold today ; to what extent have they impacted the financial models of today, what reforms did they arouse, where do these propositions stand today and how have they progressed after almost three decades of intense scrutiny , rancor debates etc. Most of these controversies can be thought off as settled today, thanks to all the research done in this regard. Miller proposed that the value of the firm was independent of its capital structure. This means that the value of the firm was not affected by tax, debt to capital ratio etc. The article claims that most of the criticism on this proposition has now been well rested and proven in different various. Miller’s proposition could only hold true in completely perfect capital structures. It cant be true in capital structures which are not in equilibrium. M and M propositions have thus revolutionalized the world of finance. They have major implications in various sectors such as money and banking, fiscal policy and international finance. It is ironic how even after thirty years, since their inception, they continue to create waves in the world of finance. Article 4: Article 4: Debt and Taxes by Merton H. Miller The article was written by Merton H. Miller. He presented Heterodox views on debt and taxes. This is a discussion on various arguments over debt and taxes in the last couple of years. The paper highlites the problems associated with corporate finance, some of the standard tools of economics and an analysis of the competitive market equilibrium. The paper answers questions such as the effect of the debt on the firm’s value and how market affects dividends. The effect debt may have on the value of the firm is debatable. Debt affects the value of the firm and risk and expected return. When a firm finances through debt, the financial risk increases which adds to the business risk shared by the shareholders. However, the expected return also increases for the shareholders. When a firm opts for the debt option, it gets a tax shield as tax is applied on earnings after interest payments. Also, earnings per share which is EBIT (1-t)/ number of shares increases as earnings would increase due to new investments, tax would decrease and the number of shareholders would remain the same, however the interest payment expense would increase and the business risk for the shareholders would increase. As an increase in debt increases the risk for shareholders and increases the expected earnings per share the effect on the value of the firm is only determined by how highly leveraged the firm is. The increase in risk puts a downward pressure on the stock price whereas the increase in expected return puts an upward pressure on stock price. Thus, a firm’s value increases due to debt till the increase in earnings per share is greater than the increase in risk. Read More