faculdade de ciências económicas e empresariais universidade católica portuguesa...

04/11/23 Ricardo F [email protected]

Faculdade de Ciências Económicas e Empresariais

Universidade Católica Portuguesa

6th session:Financial Measures of Performanceand Executive Compensation

Performance Evaluation

IMSc in Business Administration

October-November 2007




Financial accounting measures of performance

Computing Earnings per Share (EPS)

Ricardo F [email protected]

Session 02 - 3/2404/11/23Performance Evaluation



Computing Earnings per Share (EPS)

• 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.





EPS on Simple Capital Structure 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).

EPS=

Net Income

Weighted Average Number of Shares





Preferred Stock Dividends

Preferred Stock Dividends are compensation not available for common stockholders, therefore they are subtracted from the Net Income.

EPS=Net Income – Preferred Dividends

Weighted Average Number of Common Stock





Weighted Average Number od Shares Outstanding

Weighted by the fraction of the period they are outstanding

Find the equivalent number of whole shares outstanding for the year.





Stock Dividends and Stock Splits

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.





Complex Capital Structure

Dilutive securities are securities that can be converted into common stock (through conversion or exercise) and will dilute earnings per share.





Diluted EPS

Note that:

Only dilutive securities are to be reported! Antidilutive are not considered.

EPS=

Net income- Preferred dividends

-Impact of

Convertibles-

Impact of Option, Warrants, and Other Dilutive

Securities

Weighted Average Shares Outstanding





Diluted EPS – Convertible SecuritiesIf-Converted Method1. 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.





Diluted EPS – Options and WarrantsTreasury Stock Method1. 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.





ROE – Walgreen’sDupont Reduced AnalysisROE 18,42% 18,22% 17,50% 17,52%

Net Income $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

Profit Margin 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%




Executive Compensation

Stock Based Compensation Plans





Stock Compensation Plans

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.





200 top companies: M$11.3

9% 19%

14%58%

Salary

Annual incentive

Long termincentive

Stock options





Dot-coms: M$6.1

87%

7% 1%5%

Salary

Annual incentive

Long termincentive

Stock options






Effective compensation programs are the ones that:

1. Motivate employees to high levels of performance

2. Help retain executives and allow for the recruitment of new talent

3. Base compensation on employee and company performance

4. Maximize the employee’s after-tax benefit and minimize the employee’s after-tax cost

5. Use performance criteria over which the employee has control






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”.





Major reporting issues

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.





Intrinsic Value Method

Report as compensation cost: 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.





Fair value method

FASB encourages the recognition of compensation cost for the fair value of the stock-based compensation paid to employees for their services.





Fair value method

How should the compensation expense be determined?

Over what periods should the compensation expense be allocated?





Determining expense

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!





Allocating Compensation Expense

Compensation expense to be recognized over the period where the employee performs the service – service period.

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