Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
6th session:
Financial Measures of
Performance
and Executive Compensation
Performance Evaluation
IMSc in Business Administration
October-November 2007
05/11/2015
Ricardo F Reis
[email protected]
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
Financial accounting
measures of performance
Computing Earnings per Share
(EPS)
05/11/2015
Ricardo F Reis
[email protected]
Computing Earnings per Share
(EPS)
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
•
•
•
05/11/2015
Performance Evaluation
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 Reis
[email protected]
Session 02 - 3/24
EPS on Simple Capital
Structure
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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).
Net Income
EPS=
Weighted Average Number of Shares
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 4/24
Preferred Stock Dividends
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Preferred Stock Dividends are compensation
not available for common stockholders,
therefore they are subtracted from the Net
Income.
Net Income – Preferred Dividends
EPS=
05/11/2015
Performance Evaluation
Weighted Average Number of Common Stock
Ricardo F Reis
[email protected]
Session 02 - 5/24
Weighted Average Number od
Shares Outstanding
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Weighted by the fraction of the period
they are outstanding
 Find the equivalent number of whole
shares outstanding for the year.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 6/24
Stock Dividends and Stock
Splits
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 7/24
Complex Capital Structure
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Dilutive securities are securities that can
be converted into common stock
(through conversion or exercise) and will
dilute earnings per share.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 8/24
Diluted EPS
Faculdade de
Ciências
Económicas e
Empresariais
Note that:
Only dilutive securities are to be reported!
Antidilutive are not considered.
Universidade
Católica
Portuguesa
Net income- Preferred
dividends
EPS=
Weighted Average Shares
Outstanding
05/11/2015
Performance Evaluation
-
Impact of
Convertibles
Ricardo F Reis
[email protected]
-
Impact of Option,
Warrants, and
Other Dilutive
Securities
Session 02 - 9/24
Diluted EPS – Convertible
Securities
If-Converted Method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
1. 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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 10/24
Diluted EPS – Options and
Warrants
Treasury Stock Method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
1. 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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 11/24
ROE – Walgreen’s
Dupont Reduced Analysis
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
ROE
18,42%
18,22%
17,50%
17,52%
$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
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%
Net Income
Profit Margin
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 12/24
Faculdade de
Ciências
Económicas e
Empresariais
Executive Compensation
Universidade
Católica
Portuguesa
Stock Based Compensation Plans
05/11/2015
Ricardo F Reis
[email protected]
Stock Compensation Plans
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 14/24
200 top companies: M$11.3
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
Salary
9%
58%
19%
14%
Annual incentive
Long term
incentive
Stock options
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 15/24
Dot-coms: M$6.1
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
Salary
5%
7%
1%
87%
Annual incentive
Long term
incentive
Stock options
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 16/24
Stock Compensation Plans
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa

Effective compensation programs are the
ones that:
1.
2.
3.
4.
5.
05/11/2015
Performance Evaluation
Motivate employees to high levels of performance
Help retain executives and allow for the
recruitment of new talent
Base compensation on employee and company
performance
Maximize the employee’s after-tax benefit and
minimize the employee’s after-tax cost
Use performance criteria over which the
employee has control
Ricardo F Reis
[email protected]
Session 02 - 17/24
Stock Compensation Plans
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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”.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 18/24
Major reporting issues
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 19/24
Intrinsic Value Method
Faculdade de
Ciências
Económicas e
Empresariais
 Report as compensation cost:

Universidade
Católica
Portuguesa
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.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 20/24
Fair value method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 FASB encourages the recognition of
compensation cost for the fair value of
the stock-based compensation paid to
employees for their services.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 21/24
Fair value method
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 How should the compensation expense
be determined?
 Over what periods should the
compensation expense be allocated?
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 22/24
Determining expense
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 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!
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 23/24
Allocating Compensation
Expense
Faculdade de
Ciências
Económicas e
Empresariais
Universidade
Católica
Portuguesa
 Compensation expense to be recognized
over the period where the employee
performs the service – service period.
05/11/2015
Performance Evaluation
Ricardo F Reis
[email protected]
Session 02 - 24/24