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Management Control Systems

Notes 3. A manager who retires will continue to receive payments for a number of years which
augment post-retirement income and also provides a tax advantage.
4. The deferred time frame encourages longer-term thinking with regard to decision making.

Did u know? Deferred bonus plan has the disadvantage of not making the amount available
to the executives in the year when earned. Another disadvantage is that manager may not
receive the deferred bonus if he leaves the organization voluntarily (excluding disability,
death or being laid off), thus, deterring him from leaving the organization.

11.3 Long-term Incentive Plans

The basic premise of long-term incentive plans is the growth in the value of company shares;
reflect company’s long-run performance. There are several types of such plans. The popularity
of specific plan changes with factors like changes in income-tax law, changes in accounting
treatment and the state of the stock market. Some of these plans are given below:
1. Stock Options: A stock option is a right to buy a no. of shares at or after a given date in
future (the exercise date) at a price agreed upon at the time the option is granted (usually
the current market price of 95% of the current market price). The major motivational
benefit of stock option plans is that managers can directly effort towards the long-term as
well a short-term performance of the company. The manager gains if he sells the shares
later at a price that exceeds the price paid. The managers can retain equity even if they
leave the company and consider selling and making profits later on.

!
Caution Many stock options are for restricted period and can be sold only if the prescribed
period is over.
2. Phantom shares: This method awards managers a number of shares for bookkeeping
purposes. At the end of the specified period (say 5 years), the manager is entitled to receive
an award equal to the appreciation in the market value of shares since the data of award.
This award may be in cash, shares or both.
3. Stock appreciation rights: A stock appreciation right is a right to receive cash payments
based on the increase in the value of shares from the time of the award until a specified
future date.

Did u know? Both phantom shares and stock appreciation rights are a form of deferred cash
bonus, in which the amount of bonus is a function of the market price of the company’s
shares.
4. Performance shares: A performance share plan awards a specified number of shares to a
manager when specific long-term goals have been met i.e., percentage growth in earnings
per share over a three to five year period and was not influenced by stock prices due to
reasons other than increase in company’s earnings.

Notes The only disadvantage of this method is that basing the bonus on accounting
measures of performance, actions that corporate executives take to improve earnings per
share, not contributing to the economic worth of the firm.

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