The Comparison among Three Contracts Referring to Different Kinds of Instrument as Incentives to Managers: Restricted Stock, Stock Purchase Loan, and Option

Sarbanes-Oxley Act, which was passed in July 2002, has made it unlawful for any public company to provide loans to its executive officers and directors. Thus companies can no longer grant their managers stock purchase loan to help them increase ownership in company and reduce the agency problem between shareholders and managers. This article suggests that the ban of stock purchase loan to managers might harm shareholders instead of protecting them.
This article utilizes a model to analyze a situation, where agency problems exist and shareholders can only use restricted stock, stock purchase loan or stock option as incentives to induce managers devoting their effort in some investment plan. It explores the cost under each of these three incentive tools and determines which one is most beneficial for shareholders. The article concludes: the cost under each of these three incentive tools changes as the company’s situation changes, and each tool can be the most beneficial one for shareholders. Banning any one of these tools can, therefore, harm shareholders since they can no longer arbitrarily adopt a tool that benefits them most. It also suggests that forgiving loans to managers should not be thought as a direct proof of bad company governance. In fact, a positive forgiving rate of executive loan can benefit shareholders more than completely no forgiveness. At last, this article suggests that if managers’ effort is independent of or economical in the scale of investment plan, then the lager the company size is, the more suitable it is for the company to adopt restricted stock as its incentive tool.