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Question: Specific Electric Co. asks you to implement

Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in reduced personal entrepreneurship and increased stress-related health care costs or they can reduce effort, thereby avoiding the personal costs. The CEO and EVPs face three possible random outcomes: the probability of the company experiencing good luck is 30 percent, medium luck is 40 percent, and bad luck is 30 percent. Although the senior management team can distinguish the three “states” of luck as the quarter unfolds, the Compensation Committee of the Board of Directors (and the shareholders) cannot do so. Once the board designs an incentive contract, soon thereafter the good, medium, or bad luck occurs, and thereafter the senior managers decide to expend high or reduced work effort. One of the observable shareholder values listed below then results.
Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in reduced personal entrepreneurship and increased stress-related health care costs or they can reduce effort, thereby avoiding the personal costs. The CEO and EVPs face three possible random outcomes: the probability of the company experiencing good luck is 30 percent, medium luck is 40 percent, and bad luck is 30 percent. Although the senior management team can distinguish the three “states” of luck as the quarter unfolds, the Compensation Committee of the Board of Directors (and the shareholders) cannot do so. Once the board designs an incentive contract, soon thereafter the good, medium, or bad luck occurs, and thereafter the senior managers decide to expend high or reduced work effort. One of the observable shareholder values listed below then results. 


Assume the company has 10 million shares outstanding offered at a $65 initial share price, implying a $650,000,000 initial shareholder value. Since the EVPs and CEOs effort and the company’s luck are unobservable to the owners and company directors, it is not possible when the company’s share price falls to $50 and the company’s value to $500,000,000 to distinguish whether the company experienced reduced effort and medium luck or high effort and bad luck. Similarly, it is not possible to distinguish reduced effort and good luck from high effort and medium luck. 

Answer the following questions from the perspective of a member of the Compensation Committee of the board of directors who is aligned with shareholders’ interests and is deciding on a performance-based pay plan (an “incentive contract”) for the CEO and EVPs.

What is the maximum amount it would be worth to shareholders to elicit high effort all of the time rather than reduced effort all of the time?

Assume the company has 10 million shares outstanding offered at a $65 initial share price, implying a $650,000,000 initial shareholder value. Since the EVPs and CEOs effort and the company’s luck are unobservable to the owners and company directors, it is not possible when the company’s share price falls to $50 and the company’s value to $500,000,000 to distinguish whether the company experienced reduced effort and medium luck or high effort and bad luck. Similarly, it is not possible to distinguish reduced effort and good luck from high effort and medium luck. Answer the following questions from the perspective of a member of the Compensation Committee of the board of directors who is aligned with shareholders’ interests and is deciding on a performance-based pay plan (an “incentive contract”) for the CEO and EVPs. What is the maximum amount it would be worth to shareholders to elicit high effort all of the time rather than reduced effort all of the time?





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Shareholder Value GOOD LUCK MEDIUM LUCK BAD LUCK (30%) (40%) (30%) High Effort $1,000,000,000 $800,000,000 $500,000,000 Reduced Effort $ 800,000,000 $500,000,000 $300,000,000


> Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in

> Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in

> Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in

> Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in

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> Specific Electric Co. asks you to implement a pay-for-performance incentive contract for its new CEO and four EVPs on the Executive Committee. The five managers can either work really hard with 70 hour weeks at a personal opportunity cost of $200,000 in

> Airlines face highly cyclical demand; American reported profitability in the strong expansion of 2006–2007 but massive losses in the severe recession of 2008–2009. Demand also fluctuates day to day. One of the ways American copes with random demand is th

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

> The setting is a Ralph Lauren outlet store, and the product line is Polo golf shirts. A product manager and the General Manager for Outlet Sales are analyzing the discounted price to be offered at the outlet stores. Let’s work through t

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> Reid’s personal residence is condemned on September 12, 2017, as part of a plan to add two lanes to the existing highway. His adjusted basis is $300,000. He receives condemnation proceeds of $340,000 on September 30, 2017. He purchases another personal r

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> Kim owns equipment that is used exclusively in her business. The equipment has an adjusted basis of $8,500 (FMV $5,000). Kim transfers the equipment and $2,000 cash to David for a computer (also used for business purposes) that has an FMV of $7,000. a.

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> William is not married, nor does he have any dependents. He does not itemize deductions. His taxable income for 2017 was $87,000. His AMT adjustments totaled $125,000 (with the exception of the standard deduction and personal exemption). What is William’

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> Go to the IRS Web page (www.irs.gov) and print page 5 of a Form 1120. Complete Schedule M-1 for each of the following cases: a. Corporate financial statement net income of $52,000 including tax expense of $15,000, charitable contributions of $3,000, an

> Dominique is a manager for a regional bank. He is being relocated several states away to act as a temporary manager while a new branch is interviewing for a permanent manager. He will leave on May 1, 2017, and will be at the new location for less than on

> On February 1, 2017, a 39-year-old widow buys a new residence for $150,000. Three months later, she sells her old residence for $310,000 (adjusted basis of $120,000). Selling expenses totaled $21,000. She lived in the old house for 15 years. a. What are

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> What is Schedule M-1, and what is its purpose?

> In what circumstances does a corporation record a gain related to a distribution to a shareholder?

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> Explain the rules associated with the carryback and carryforward of net operating losses.

> On what dates are estimated payments due for a calendar year corporation? What are the dates for a corporation with a fiscal year ending August 31?

> When an involuntary conversion occurs and the taxpayer receives insurance proceeds, what must the taxpayer do to guarantee that no gain is recognized?

> What is an involuntary conversion?

> Explain the rules pertaining to the deductibility of charitable contributions for a C corporation.

> What are the special provisions for like-kind exchanges between related-parties? Why are these special provisions included in the IRC?

> What is a passive activity? What types of activities are automatically considered passive?

> Must both parties in a potential like-kind exchange agree to the exchange? If not, how can the transaction be structured to defer any gain?

> When a loss is disallowed under the passive activity loss rules, what happens to that loss in future years?

> Discuss the concept of material participation. To be considered a material participant, what tests must the taxpayer satisfy?

> What is boot? How does the receipt of boot affect a like-kind exchange?

> Without regard to any extensions of time to file, when is the income tax return due for a corporation with a May 31 year-end? An August 31 year-end? A February 28 year-end?

> What types of properties do not qualify for like-kind exchange treatment?

> Can the exchange of personal-use property qualify as a like-kind exchange? Why or why not?

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> Determine the deductible charitable contribution in each of the following instances. a. Charitable contribution of $4,000 and taxable income before charitable contribution of $50,000. b. Charitable contribution of $8,000 and taxable income before charita

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> Determine the amount of dividends received deduction in each of the following instances. In all cases, the net income figure includes the full dividend. a. Dividend of $10,000 from a 45% owned corporation; taxable income before DRD of $50,000. b. Divide

> Explain the rules associated with capital loss carrybacks and carryforwards.

> Explain the operation of the dividends received deduction.

> Using the information from Problem 47, determine the basis of the property contributed in the hands of the corporation in each instance. Assume that the 80% rule is met in all cases. Data from question 47: Determine the basis of stock in the hands of th

> Determine the basis of stock in the hands of the shareholder in each of the following instances. Assume that the 80% rule is met in all cases. a. Contribution of property with a basis of $1,000 and an FMV of $1,400. b. Contribution of property with a bas

> An individual contributes property with an FMV in excess of basis to a corporation in exchange for stock. The property is subject to a mortgage. In each of the following instances, determine the basis of the stock in the hands of the shareholder and the

> Refer to Problem 58. Determine the amount of taxable income and separately stated items in each case, assuming the corporation is a Subchapter S corporation. Ignore any carryforward items. Data from question 58: Go to the IRS Web page (www.irs.gov) and

> Refer to Problem 54. Determine the amount of taxable income and separately stated items in each case, assuming the corporation was a Subchapter S corporation. Data from question 54: Determine taxable income in each of the following instances. Assume tha

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> LMNO Corporation was formed in 2010. It reported net income (loss) over the 2009 through 2016 tax years, before accounting for any net operating losses, as follows: 2010 $ (4,000) 2011 $ 19,000 2012 $ 23,000 2013 $ (31,000) 2014 $ 11,000 2015 $ ( 8,000)

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> What is the dividends received deduction? What is its purpose?

2.99

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