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ACCA Strategic Professional · Advanced Performance Management · Performance and reward

Karvel Ltd grants its chief executive 100,000 share options with an exercise price of $4.00, equal to the market price at grant. The options vest after three years if the CEO remains employed, with no performance conditions. Over the vesting period the whole stock market rises strongly, lifting Karvel's share price to $6.50 although the company's performance was below that of its peers. What is the main weakness of this scheme illustrated by the outcome?

The main weakness is that the CEO is rewarded for a general market rise rather than for company-specific performance. With no performance conditions or peer comparison, the options gained value even though Karvel underperformed its peers, so reward is not aligned with managerial contribution.

  1. AThe CEO is rewarded for general market movements rather than for the company's own performanceCorrect
  2. BThe exercise price is too low relative to the market price at grant, so options are issued at a discount
  3. CThe vesting period is too long to be motivational
  4. DThe scheme exposes the CEO to downside risk, so it discourages risk taking

Explanation

Without performance conditions or relative targets, option value rises with the overall market, so the CEO gains $250,000 (100,000 x $2.50) despite underperforming peers. The exercise price equals market price at grant, so it is not discounted, and options carry no downside loss beyond zero value.

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