Brenda, a concerned member of the Board of Directors of a firm that produces oil and gas has reached out to you for advice about how to structure the compensation of its senior management team. The firm owns producing wells that are currently producing oil and gas which it sells to refineries. The firm is also engaged in the acquisition of drilling rights from landowners. If the firm analyzes geological data and perceives there is a sufficiently high probability of accessible oil or gas deposits it negotiates a fee payment to the landowner for drilling rights and commences to drill exploratory wells. Brenda confides in you her concern: "These people (senior management) are really good people but they are old school oil people. They love to study geological reports and drill. The highlight of their year is to go to the Oklahoma State University Geology Department Alumni Reunion and swap drilling stories with their classmates."1 Explain to Brenda, 

(1) how a leverage recapitalization could be a solution to her concerns about management and 

(2) that she should think about a leverage recapitalization instead of trying to adjust the structure of senior management compensation. Note- Of course Brenda does not care about alumni gatherings per se. However, the alumni gatherings shed light on the senior manager's utility function. 

 

Answer rating: 100% (QA)

1 A leverage recapitalization involves increasing the proportion of debt in a company... View the full answer