Lyft launched its IPO on April 1st 2019 with a share price of $72. Before the IPO, Lyft’s board of directors was likely trying to decide how to compensate CEO Logan Green to provide an incentive for him to increase the firm’s performance and share price after it went public. Let’s say the board was considering two possibilities such that they were deciding between providing one million dollars worth of shares of the firm stock at $72 per share or one million dollars worth of call options with a strike price of $72 and a maturity and vesting date one year after the IPO. To keep things simple, let’s say CEO Logan Green can choose between providing two levels of effort: regular effort or high effort. He has been exerting regular effort all along. He could switch to high effort which would be much more costly for him as he would have to work even longer hours, but the extra effort would likely result in better performance for the firm. The goal of the board’s incentive compensation is to convince the CEO to exert high effort, and we want to consider the incentive created by giving him either shares of stock or stock options. To determine the incentive created under shares versus options, we first have to know how many shares or options the one million dollars of incentive compensation would provide. We already know the price of a share of stock ($72), but we have to determine the price of the option to know how many options to provide. Remember that we determine the price of an option by considering the various values the stock price might be at the time of the option maturity. Let’s say the board assumes the CEO will exert regular effort and under that level of effort works with market analysts to predict the value of a share of the stock one year after the IPO. They conclude the share price one year after the IPO has the following probabilities: a 30% chance of $42 per share, a 10% chance it is $35 per share, a 30% chance it is $60 per share, a 20% chance of it being $74 per share, and a 10% chance if it being $80 per share.

Lyft launched its IPO on April 1st 2019 with a share price of $72. Before the IPO, Lyft’s board of directors was likely trying to decide how to compensate CEO Logan Green to provide an incentive for him to increase the firm’s performance and share price after it went public. Let’s say the board was considering two possibilities such that they were deciding between providing one million dollars worth of shares of the firm stock at $72 per share or one million dollars worth of call options with a strike price of $72 and a maturity and vesting date one year after the IPO. To keep things simple, let’s say CEO Logan Green can choose between providing two levels of effort: regular effort or high effort. He has been exerting regular effort all along. He could switch to high effort which would be much more costly for him as he would have to work even longer hours, but the extra effort would likely result in better performance for the firm. The goal of the board’s incentive compensation is to convince the CEO to exert high effort, and we want to consider the incentive created by giving him either shares of stock or stock options. To determine the incentive created under shares versus options, we first have to know how many shares or options the one million dollars of incentive compensation would provide. We already know the price of a share of stock ($72), but we have to determine the price of the option to know how many options to provide. Remember that we determine the price of an option by considering the various values the stock price might be at the time of the option maturity. Let’s say the board assumes the CEO will exert regular effort and under that level of effort works with market analysts to predict the value of a share of the stock one year after the IPO. They conclude the share price one year after the IPO has the following probabilities: a 30% chance of $42 per share, a 10% chance it is $35 per share, a 30% chance it is $60 per share, a 20% chance of it being $74 per share, and a 10% chance if it being $80 per share.

Managerial Economics: Applications, Strategies and Tactics (MindTap Course List)

14th Edition

ISBN:9781305506381

Author:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Publisher:James R. McGuigan, R. Charles Moyer, Frederick H.deB. Harris

Chapter1: Introduction And Goals Of The Firm

Section: Chapter Questions

Problem 1.6CE

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