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ACCA Strategic Professional · Advanced Performance Management · Performance and reward

Castellan Ltd grants its directors share options exercisable in three years at the current market price of $5.00. Over the period, a general market rise lifts the share price to $7.00, although Castellan's performance was below that of its sector peers. What is the main weakness this illustrates in the share option design?

The weakness is that options reward directors for general market movements outside their control. Here the share price rose because the market rose, not because Castellan outperformed peers, so directors gain unearned reward unless a relative performance condition is attached.

  1. AOptions reward directors for market-wide movements not linked to their own performanceCorrect
  2. BOptions create an immediate cash cost that reduces reported profit by the full $2.00 gain
  3. COptions can only be exercised if the directors sell shares to shareholders at a discount
  4. DOptions prevent directors from benefiting when the share price falls

Explanation

The $2.00 gain arises from a general market rise, so directors profit despite underperforming peers. Using a relative performance condition, such as total shareholder return versus a peer index, would filter this out. The other options misdescribe how options work.

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