Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa...
Transcript of Faculdade de Ciências Económicas e Empresariais Universidade Católica Portuguesa...
04/11/23 Ricardo F [email protected]
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
6th session:Financial Measures of Performanceand Executive Compensation
Performance Evaluation
IMSc in Business Administration
October-November 2007
04/11/23 Ricardo F [email protected]
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Financial accounting measures of performance
Computing Earnings per Share (EPS)
Ricardo F [email protected]
Session 02 - 3/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Computing Earnings per Share (EPS)
• Earnings per share indicates the income earned by each share of common stock.
• Reported at the end of the income statement
• Should report intermediate components as well.
Ricardo F [email protected]
Session 02 - 4/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
EPS on Simple Capital Structure Simple Capital Structure means that there is
only common stock and there is no potential common stock (securities that can potentially be converted into common stock and dilute EPS).
EPS=
Net Income
Weighted Average Number of Shares
Ricardo F [email protected]
Session 02 - 5/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Preferred Stock Dividends
Preferred Stock Dividends are compensation not available for common stockholders, therefore they are subtracted from the Net Income.
EPS=Net Income – Preferred Dividends
Weighted Average Number of Common Stock
Ricardo F [email protected]
Session 02 - 6/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Weighted Average Number od Shares Outstanding
Weighted by the fraction of the period they are outstanding
Find the equivalent number of whole shares outstanding for the year.
Ricardo F [email protected]
Session 02 - 7/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Stock Dividends and Stock Splits
When these happen computation of the average number of shares outstanding needs to be redone.
A stock dividend or split does not change the shareholders’ total investment.
Ricardo F [email protected]
Session 02 - 8/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Complex Capital Structure
Dilutive securities are securities that can be converted into common stock (through conversion or exercise) and will dilute earnings per share.
Ricardo F [email protected]
Session 02 - 9/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Diluted EPS
Note that:
Only dilutive securities are to be reported! Antidilutive are not considered.
EPS=
Net income- Preferred dividends
-Impact of
Convertibles-
Impact of Option, Warrants, and Other Dilutive
Securities
Weighted Average Shares Outstanding
Ricardo F [email protected]
Session 02 - 10/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Diluted EPS – Convertible SecuritiesIf-Converted Method1. Conversion of the convertible securities
as soon as possible (beginning of period or issuance)
2. Elimination of related interest, net of tax.
Logic is that if the convertible securities were converted, then they didn’t produce any interest and net income has to be filtered of this.
Ricardo F [email protected]
Session 02 - 11/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Diluted EPS – Options and WarrantsTreasury Stock Method1. Exercise of options or warrants as soon
as possible (beginning of period or issuance)
2. Proceeds from the exercise are used to purchase common stock.
Ricardo F [email protected]
Session 02 - 12/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
ROE – Walgreen’sDupont Reduced AnalysisROE 18,42% 18,22% 17,50% 17,52%
Net Income $1.750,60 $1.559,50 $1.349,80 $1.176,00
Net Sales $47.409,00 $42.201,60 $37.508,20 $32.505,00
Common Equity $10.115,80 $8.889,70 $8.227,00 $7.196,00
Total Assets $17.131,10 $14.608,80 $13.342,00 $11.658,00
Profit Margin 3,69% 3,70% 3,60% 3,62%
Assets Turnover 2,99 3,02 3,00 3,02
Financial Leverage 1,67 1,63 1,62 1,60
18,42% 18,22% 17,50% 17,52%
04/11/23 Ricardo F [email protected]
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Executive Compensation
Stock Based Compensation Plans
Ricardo F [email protected]
Session 02 - 14/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Stock Compensation Plans
Warrants used to pay and motivate employees
Stock option gives selected employees the right to purchase common stock at a given price over an extended period of time.
Ricardo F [email protected]
Session 02 - 15/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
200 top companies: M$11.3
9% 19%
14%58%
Salary
Annual incentive
Long termincentive
Stock options
Ricardo F [email protected]
Session 02 - 16/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Dot-coms: M$6.1
87%
7% 1%5%
Salary
Annual incentive
Long termincentive
Stock options
Ricardo F [email protected]
Session 02 - 17/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Stock Compensation Plans
Effective compensation programs are the ones that:
1. Motivate employees to high levels of performance
2. Help retain executives and allow for the recruitment of new talent
3. Base compensation on employee and company performance
4. Maximize the employee’s after-tax benefit and minimize the employee’s after-tax cost
5. Use performance criteria over which the employee has control
Ricardo F [email protected]
Session 02 - 18/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Stock Compensation Plans
Cash compensation is important, but they are short-run oriented
Long-term compensation plans develop in key employees a strong loyalty towards the company, by giving them “a piece of the action”.
Ricardo F [email protected]
Session 02 - 19/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Major reporting issues
What is being granted when you grant stock options? What is the cost?
Suppose you are granted ptions to purchase 10,000 shares of the firm common stock as part of your compensation. The options are good for 10 years, the market and exercise price are both $20 at the grant date.
Ricardo F [email protected]
Session 02 - 20/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Intrinsic Value Method
Report as compensation cost: The difference bewteen the market price of
the stock and the exercise price of the options at the grant date.
So in this case, the cost of granting these options would be 0.
Ricardo F [email protected]
Session 02 - 21/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Fair value method
FASB encourages the recognition of compensation cost for the fair value of the stock-based compensation paid to employees for their services.
Ricardo F [email protected]
Session 02 - 22/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Fair value method
How should the compensation expense be determined?
Over what periods should the compensation expense be allocated?
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Session 02 - 23/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Determining expense
Total compensation expense is computed based on the fair value of the option expected to vest on the grant date.
Fair value for public companies is to be estimated using an option pricing model.
No adjustments are to be made after the grant date!
Ricardo F [email protected]
Session 02 - 24/2404/11/23Performance Evaluation
Faculdade de Ciências Económicas e Empresariais
Universidade Católica Portuguesa
Allocating Compensation Expense
Compensation expense to be recognized over the period where the employee performs the service – service period.