Answer the following questions and make two peer responses per question:
- 1. What factors improve the effectiveness of a board of directors?
- 2. Describe how a typical stock option plan works. What are some of the problems with a typical stock option plan?
- 3. Explain an optimal dividend policy for a mature company that has decided to pay a dividend. Also, how does this affect a firm’s capital structure?
- 4. Discuss any recommendations that you have to improve this course.
Your initial post for each question should be roughly 300 to 500 words in length, and your responses to peers should be roughly 100 to 200 words each. Cite sources you reference as an in-text citation and under the post include a “References” section in APA format.
Post by classmate 1
1. What Factors Improve the Effectiveness of a Board of Directors?
An effective board of directors is essential for a company’s long-term success, aligning management decisions with shareholders’ interests. Key factors include board independence, where a majority of independent directors ensures objectivity and minimizes conflicts of interest (Brigham & Ehrhardt, 2020). Diversity in gender, ethnicity, and experience enhances decision-making by bringing varied perspectives to address issues like corporate responsibility and global challenges. Clear roles and responsibilities between the board and management ensure effective governance and oversight. Committees like audit and governance further distribute responsibilities.
Regular self-evaluations help identify areas for improvement, ensuring directors contribute effectively. Additionally, informed decision-making relies on the board staying updated on the company’s financial health and business environment, aided by management and independent advisors. Finally, active engagement and accountability, with directors attending meetings and ensuring transparent reporting, enhances the board’s credibility and effectiveness. These factors enable boards to better guide companies and foster long-term success.
2. Describe How a Typical Stock Option Plan Works and Problems with a Typical Stock Option Plan
A stock option plan allows employees to buy company stock at a fixed “exercise” price for a specified period, often several years. This plan aligns employee interests with shareholders and incentivizes performance (Jensen & Meckling, 1976).
Stock options typically have a vesting period, requiring employees to stay with the company for a set time (e.g., three to five years) before exercising the options. Expiration dates generally require options to be exercised within 10 years, after which they become void. Once the stock price exceeds the exercise price, employees can sell for a profit, such as buying at $50 and selling at $70 for a $20 gain.
Problems with Stock Option Plans:
Stock options can dilute existing shareholders’ equity, as issuing new shares increases the number of outstanding shares, potentially reducing their value. They can also promote a short-term focus, pushing executives to prioritize quick stock price gains over long-term company health. Accounting complexities arise because options must be expensed, affecting financial statements. Additionally, there is a risk of manipulation, where executives may inflate stock prices for personal gain, disregarding long-term stability. While stock options align employee and shareholder interests, they must be carefully structured to mitigate these risks and potential abuses.
3. Explain an Optimal Dividend Policy for a Mature Company That Has Decided to Pay a Dividend
An optimal dividend policy for a mature company balances shareholder expectations with financial stability and growth potential. Mature companies that have fewer high-growth opportunities, often return profits to shareholders via dividends.
Important Facts:
- Sustainability: Dividends should be consistently paid, even during downturns, to avoid signaling instability and eroding confidence.
- Growth and Flexibility: A progressive policy, gradually increasing dividends as earnings grow, rewards shareholders while allowing reinvestment when needed.
- Capital Structure: Dividends reduce retained earnings, which could otherwise fund investments or debt repayment, so the policy must balance cash outflows without hindering future growth or increasing leverage.
Effect on Capital Structure:
Paying dividends reduces the company’s internal funds, which may lead the firm to rely more on external financing for future projects. While moderate use of debt can benefit companies by providing tax shields, excessive debt can increase financial risk. Therefore, mature companies often strike a balance by maintaining a dividend policy that keeps their debt-to-equity ratio at a healthy level, ensuring both financial flexibility and shareholder satisfaction.
4. Discuss any recommendations that you have to improve this course.
I would encourage your students in the future to either buy a paperback version of the text book, or a digital lifetime copy of the textbook. I can see myself in the next 5-10 years coming back to re-read sections of this book.
References
- Brigham, E. F., & Ehrhardt, M. C. (2020). Financial Management: Theory and Practice. Cengage Learning.
- Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305-360.
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