Day 3: Agenda

1. Day 3: Agenda • Admin • scholarship info • prerequisite signoffs • pix anyone? • P&R: collect/return • Reaction paper 1 - identify 3 issues. Discuss one in depth and the rest in less detail

2. Stock Options: 1 • Stock options are the right to buy stock at a given price (the exercise price) at a given date (the exercise date). • If you can keep the rights when you leave the firm, the rights are vested, if not too bad. • If the current stock price is above the exercise price, your option is in-the-money, if not, it is out-of-the-money.

3. Stock Options: 2 • When an option is given, it has value. • Would you work for a piece of paper that has no value? • The value comes out of the total market value of the firm (i.e. the owner’s wealth). • Think of the Scrooge-Cratchitt example we discussed last class.

4. Stock Options: 3 • It may not have a cost as measured by “traditional” accounting rules. • The employee has not yet purchased the shares, so transaction between the entity and the employee. • HOWEVER, it is a promise to pay, so it IS a potential liability. • How to deal with this? Disclose? Recognize? • What $ value to put on this?

5. Principal-Agent Theory: 1 • What is the crux of the agency problem? • Self interested behavior by the agent AND the principal’s inability to write contracts based on agent’s behavior. • What is the best that can be done? • One way is to write contracts based on outcomes. This exposes agents to risk. Since the agent is assumed to be less risk-loving than the principal, this is inefficient.

6. Principal-Agent Theory: 2 • How do we know what the outcome was? • Credible reporting by agent coupled with attestation or auditing. • Role of accounting (and accounting standards) in reducing contracting costs • Value of accounting & auditing • increase in value of firm due to better contracts.