Question

Minhat and Abdullah (2016) suggest that paying bankers with stock options can
generate two types of managerial incentives, namely, incentives to improve
performance and incentives to take risk.

i. Critically discuss conflict of interests from the perspective of the theory of the
firm.

ii. Critically evaluate whether the use of stock options could mitigate or exacerbate
conflict of interests.

Answer 1

Offering stock options to the employees is growing in popularity and is also called as ESOP (Employee Stock Option Planning). It is a way to retain the talent. The share purchase gives a stake in the business you are working, you could see bif profit if the company is successful. Company grants stock options through a contract that gives the employee the right to buy which is also called exercise a set number of shares of the company stock at a pre-set price (Known as grant price). This offer is not available always. There is a time to it before it expires. The number of options one receive is dependent on seniority level and investors and other stake holders also sign off before any employee receive stock options. The options will have a vesting date and expiration date. You cannot exercise the options before the vesting date or after the expiration date.

a)Though there is significant advantage to ESOP such as increase innovation, increase customer loyalty, increase shareholder value, motivate employees , increase job satisfaction etc. The main problem with the ESOP is when the share price keeps on falling , the employee feels that he dont have control over the price of the share of the company he is working thats when it affects the morale of the employee. This is known as "Insider Trading". It is when the insiders want to benefit from the company information at the cost of the company. For Example. lets say the employee knows the insider information that the company is going to make a big investment in some other country where there is huge demand for the product it produces, the employee starts buying the shares before the company actually announces it to the media. This needs to be reported to SEC (Securities and Exchange Commission). This is illegal. This is called as Misappropriation Theory which says that a person who uses insider information in trading securities has committed securities fraud against the information source. Hence there is conflict of interest on part of the employee in the greed of making more money that he foregoes the company and its ethical values.

b) The information assymetry is utilized by the employee to gain benefit of share price rise. The use of stock options could exacerbate the conflict of interests. But a strict company law and the Security Board  will help to mitigate such case. In USA the employee is sentenced for 20 years imprisonment and a maximum criminal fine of $5,000,000.