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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