Analysis
Team 4 (Ben / Garst)
“Assuming further that the Ovitz at least performs adequately for the five
year term, we would be earn $21 to $35 million annually- a rather sizeable
but not wholly unrealistic number. The deal falls apart, however, if he is
fired for no fault early in the contract. Obviously the board was banking on
that not happening.”
Critique
Team 12 (Kelli / Will)
Team Four fails to mention what would have happened to Ovitz’s
compensation package had he actually resigned from the Disney, rather than
being terminated, either with or without cause
Team Four failed to really explain how the model works, and although
familiar with the overall concept, we were unable to follow their calculations
Black - Scholes Option Pricing Model
Current Value Of Underlying Asset
Exercise Price
Risk-Free Interest Rate (Annual)
Variance Of Price Of Underlying
Asset (Annual)
Time To Maturity (Years)
Standard Deviation Of Price Of
Underlying Asset
d1
d2
$64.98
$64.98
6.20% -->
Value Of Call Option
Hedge Ratio (Option Delta)
$33.67
0.8880
5.29% =SD^2 -->
10.00
23.00%
1.22
0.49
Value of Put Option
$4.30
Terminate
Value of A options
Value of B options
Years of service
Annual value of options
Salary
Total annual compensation (w/o term.
"bonus")
From Disney's 1997
10-K note 9
$101,009,987.67
No renewal
$101,009,987.67
Renewal
1
$101,009,987.67
$1,000,000.00
5
$20,201,997.53
$1,000,000.00
$101,009,987.67
$67,339,991.78
5
$33,669,995.89
$1,000,000.00
$102,009,987.67
$21,201,997.53
$34,669,995.89
Analysis
Team 10 (Guarav, John)
The most irrational, absurd part of this compensation package was that the
termination clause was so favorable for Ovitz that he would have every
incentive to find a way to exit Disney via a non-fault termination as soon as
possible
Crystal later admitted to his oversight and said the package was “shocking
amount of severance” and he wished he had calculated the cost. Had he
done so, it is unlikely that he would have made the same advice to the board.
Critique
Team 8 (Kristi / Norman)
classic cronyism led to windfall profits for Ovitz, but our question is did this
really result in a loss of shareholder value?
At first glance, this may seem to sacrifice shareholder value but stock
options should not affect the value of the company. Is it possible this clause
may actually help preserve shareholder value?\
What makes compensation excessive?
Team 7 (Ilya / Satyen)
. Ideally the option component of the compensation package should have
been valued under various scenarios or different exercise dates.
As our calculations show in Exhibit 2, Ovitz could have received
11.127 M following the non-fault termination using expected values based
on hypothetical probabilistic distribution and that was greater than the
9.39M that he would have received had he stayed for the entire 5 year
tenure. Thus, regardless of whether the board was aware of these numbers,
we find that the Old Board should have found that the compensation offered
Ovitz was neither cost-effective nor did it align Ovitz’ managerial interests
with his ownership (shareholder) interests.
As the court points out, the alternatives to the non-fault termination are an
actual resignation or a firing for “good cause.” There were no facts alleged
that show that Ovitz actually resigned. In addition, for “good cause” to exist,
there must be gross negligence or malfeasance.
Critique
Team 5 (Stacy / Adam)
The group’s idea on having an independent consultant have a more active
role in crafting the compensation packages for top executives is very good
and, from a liability standpoint, it seems it would actually be in the board’s
best interest to do so.
In our opinion, it is difficult to say that the board had exercised any level of
reasonableness when it accepted the compensation package and, as a result,
had broken its fiduciary duty to the shareholders.
The final question is one of policy. Is the prevailing standard too high and
are courts giving too much deference through the business judgment rule?
Exhibit-1
The way the options were initially valued
Current Stock Price
Strike Price of the Option
Expiration of the Option
Standard Deviation of the Stock
Dividend Yield
T. Bond Rate
No of Options
No of Shares Outstanding
35
40
3
25%
5%
7.25%
1,000,000
200,000,000
35
40
2
25%
5%
7.25%
1,000,000
200,000,000
35
40
1
25%
5%
7.25%
1,000,000
200,000,000
Value of the Call Options
Aggregate Value of the Option
$4.30
$4,300,000.00
$3.26
$3,260,000.00
$1.83
$1,830,000.00
Total Value
$9,390,000.00
Exhibit-2
The way options could have been valued if there was a non fault termination
Current Stock Price
Strike Price of the Option
Expiration of the Option
Standard Deviation of the Stock
Dividend Yield
T. Bond Rate
No of Options
No of Shares Outstanding
35
40
4
25%
5%
7.25%
3,000,000
200,000,000
35
40
3
25%
5%
7.25%
3,000,000
200,000,000
35
40
2
25%
5%
7.25%
3,000,000
200,000,000
35
40
1
25%
5%
7.25%
3,000,000
200,000,000
$4.96
$4.17
$3.13
$1.72
0.3
0.3
0.2
0.2
$1.49
$1.25
$0.63
$0.34
Expected Aggregate Value
$4,464,000.00
$3,753,000.00
$1,878,000.00
$1,032,000.00
Total Value
$11,127,000.00
Value of the Call Option
Probability of Non - Fault Termination
Expected Value of the Call Option
Analysis
Team 11 (Catherine / Brent)
the severance package can be defended because Ovitz was a high powered
Hollywood insider. The opportunity costs for him to come and work for
Disney would be very significant
We use the average value of the option, risk-free rate, and variance of price
from the Disney Annual Report for 1996. We found the stock price for
December 11, 1996 from yahoo finance and backed into what Ovitz would
have to pay Disney for the option and what he could then turn around and
sell it for on that date. Ovitz had 3 million option shares vest immediately
when he was granted a no fault termination. His gain on one share would
have been $72.12 – $33.17 = $38.95. Multiply that by 3 million and you get
a value to Ovitz of $116,860,176.97.
we believe a reasonable board would have recognized the chance to settle at
an amount less than 140 million, especially considering Ovitz’s questionable
job performance. Therefore, we think the board’s decision is unjustifiable
under the Business Judgment Rule.
Black - Scholes Option Pricing Model
Current Value Of Underlying Asset
Exercise Price
Risk-Free Interest Rate (Annual)
Variance Of Price Of Underlying Asset (Annual)
Time To Maturity (Years)
Standard Deviation Of Price Of Underlying Asset
d1
d2
Value Of Call Option
Hedge Ratio
$33.17
$72.12
6.20%
46.00%
10.00
67.82%
1.00
-1.15
$23.01
0.8412
Critique
Team 1 (Ashley, Steve)
We believe it is not the court’s place to decide whether or not Ovitz’s
compensation is fair substantively, but to determine whether or not the board
breached a fiduciary duty to the shareholders in approving Ovitz’s pay and
terminating him without cause (an analysis of the process).
The court should only determine whether the board’s actions broke the law not if the board practiced good corporate governance.
FASB’s recent revision of SFAS 123 (which requires firms to value stock
option compensation cost using the “fair value” versus the “intrinsic value”
as of the grant date and recognizing the expense over the service period,
usually the vesting period). The fair value is derived using an option based
model like the Black-Scholes-Merton (BSM) model demonstrated in Team
11’s analysis or a binomial lattice model.
Black - Scholes Option Pricing Model
Current Value Of Underlying Asset
Exercise Price
Risk-Free Interest Rate (Annual)
Variance Of Price Of Underlying Asset (Annual)
Time To Maturity (Years)
Standard Deviation Of Price Of Underlying Asset
d1
d2
$71.25
$57.44
6.20%
5.29%
9.00
23.00%
1.47
0.78
Value Of Call Option
Hedge Ratio
$40.49
0.9287
Value of Ovitz's 3,000,000 options
Stock price pulled from Yahoo finance for 12/26/1996
Exercise price is highest cited in 1995 AR for those granted in 1995
Risk-Free Interest Rate and Variance taken from 1997 10-K
$121,463,755.98