Week Four Discussion Replies. Reply to the TWO students discussion Post. 100-200 word each post.

Please respond to the TWO students' discussion Posts. peers should be roughly 100 to 200 words each. Cite sources you reference as an in-text citation, and under the post, include a “References” section in APA format.

Vincent Jones

When I think about what makes a board of directors effective, there are a few key factors that I think are important. First, board independence is critical. When a majority of directors are independent from management, they are more likely to fairly evaluate executive performance and challenge decisions when necessary. Along with independence, diversity of experience matters a lot. I think that boards that include members with different professional backgrounds finance, operations, legal, and even industry-specific expertise tend to make better strategic decisions because they can view issues from multiple perspectives. I feel like clear roles and accountability also improve board effectiveness. When responsibilities like oversight, risk management, and CEO evaluation are clearly stated, the board can focus on long-term value creation rather than micromanaging daily operations. Finally, active engagement is essential. An effective board doesn’t just approve any management proposals; it asks tough questions, monitors performance, and aligns executive incentives with shareholder interests.

A typical stock option plan is designed to motivate executives and key employees by giving them the right to buy company stock at a fixed “exercise” or “strike” price, usually equal to the stock’s market price on the grant date. These options usually vest over time, meaning employees must stay with the company for a certain period before they can exercise them. The idea is that if the stock price increases, employees benefit financially, which should encourage them to work toward improving firm performance and shareholder value. A lot of companies are doing this now like Amazon and Starbucks it seems to work and employees are more invested in the company then.

I also think that stock option plans have some well-known problems. One major issue is that they can reward executives for market-wide stock increases rather than firm-specific performance. Even if management makes poor decisions, rising markets can still lead to large option gains. Another concern is excessive risk-taking. Because options provide upside without much downside, managers may be tempted to pursue overly risky projects that could harm the firm in the long run. Stock options can also weaken existing shareholders when exercised, which may reduce overall shareholder value if not managed carefully.

For a mature company that has decided to pay dividends, an ideal dividend policy typically involves paying a stable and predictable dividend that reflects the firm’s consistent cash flows. Mature firms have fewer high-growth investment opportunities, so returning excess cash to shareholders makes sense. A stable dividend policy also sends a positive signal to investors about financial strength and future earnings stability. From a capital structure perspective, paying dividends reduces retained earnings, which may increase the firm’s reliance on external financing if new investments arise. Over time, this can lead to a higher proportion of debt or equity financing, affecting the firm’s leverage and weighted average cost of capital. When managed properly, a balanced dividend policy can hopefully support shareholder confidence while maintaining a healthy capital structure.

References:

Ehrhardt, M. C., & Brigham, E. F. (2024). Corporate finance: A focused approach (8th ed.). Cengage Learning.

Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. American Economic Review, 76(2), 323–329.

 

Colin Baker

There are many factors that can improve the effectiveness of a board of directors, as discussed in our textbooj (Brigham & Erhardt, 2024). The first idea is that the CEO should not be the chairman of the board. This prevents situations where the CEO has indirect control of who comprises the board by preventing them influencing and/or directing the names that the nominating committee submits for vote. Secondly, the board should have a majority of true outsiders with business expertise that are not too busy with other activities. This creates an engaged board that like a third-party is dispassionate towards internal politics and pet projects, allowing it to focus on maximizing shareholder wealth. Thirdly the board should be not too large, approximately 10-12 members, since individual participation drops as group size increases. Lastly, the board should be appropriately compensated in a way that also exposes them to equity risk in order to stay focused on their primary task.

            Stock option plans are great for achieving this “appropriate” compensation. A stock option is simply an option to buy a certain stock at a specific strike price before a set expiration date. A compensation plan involving stock options should theoretically align a manager with behaviors that maximize the company’s value, since that will raise the value of their own options. However, there are two reasons this is not always the case (Brigham & Erhardt, 2024). The first major issue is the idea that an executive may choose to illegally manipulate financial records to improve their stock options. The second issue is that the executive will benefit simply if the price of the stock increases, no matter how small. Whereas a wealth maximizing manager should focus on ensuring the stock increases by its expected annual appreciation, a stock option compensation plan can give an executive more money even though they underperform shareholder expectations.

            A mature company that has chosen to pay a dividend must calculate what their optimal dividend policy should be. Ideally, a manager should use the residual distribution model applied to a long-term framework to set their dividend policy (Brigham & Erhardt, 2024). Since investors do not like dividend cuts, the dividend policy should be stable but low enough that even in lean years it can be fulfilled. In more profitable years, a special dividend can be considered above and beyond the annual dividend. This affects the firm’s target capital structure by setting a limit that equity costs should be able to be covered by retained earnings, so that the firm can avoid issuing new stock.

            This was an excellent course. I came in with very little knowledge about finance and four weeks later, I can now follow a general conversation about the topic and even provide a modicum of input. The homework problems in this class were great, however I do tend to learn through repetition. It’s hard to tangibly apply, but I would volunteer for a higher volume of “simple to complex” uses of the financial formulas discussed in the book, and less writing discussions.  

References

Eugene F. Brigham, & Michael C. Ehrhardt. (2024).  Corporate Finance: A Focused Approach (8th Edition). Cengage Learning, Inc.  https://online.vitalsource.com/reader/books/9798214584249/epubcfi/6/2[%3Bvnd.vst.idref%3Dcover-page]!/4/2[cover-page]/6[EYBS9QXYGD16YZT2E049]/2%4050:40