On October 15, 2006, Mr. McGuire resigned, following a report from a law firm engaged by the board that he had benefited from late timing of ESO grants and had not disclosed a conflict of interest with the chair of UnitedHealth’s compensation committee.
On November 8, 2006, the company announced that it had agreed with Mr. McGuire to increase the exercise price of ESOs awarded to him from 1994 to 2002 to the highest share price for the year the ESOs were awarded, resulting in a material reduction in the value of the awards. Similar repricing applied to other senior officers. The company also announced that its financial statements from 1994 to 2005 could no longer be relied on, and that it would delay filing its financial results for third quarter, 2006, until the amounts of earnings restatements were fully determined. In December 2007, Mr. McGuire agreed to return about $ 468 million of ESOs and other benefits to the company.

Required
a. Use efficient contracting theory to explain why a company awards ESOs as compensation.
b. Use the power theory of compensation to explain why a company may engage in late timing of ESO awards.
c. UnitedHealth shares are listed on the New York Stock Exchange. On May 11, 2006, the Dow Jones Index fell by 141.92 points, a decline of 1.22%. UnitedHealth’s stock beta at this time was 0.4, according to Reuters/ business. The risk- free interest rate was 5%, or about 0.0001 per day. Calculate the abnormal return on UnitedHealth shares for May 11.
d. The company stated that there would be no effect on cash flows as a result of its reductions in reported earnings ( presumably, it felt any effect on income tax would be negligible). If so, give reasons why its share price fell on May 11.
e. During the years of UnitedHealth’s late timing, the rules of APB 25 applied (see Section 8.6). Explain why correcting the late timing resulted in an increase in compensation expense under APB 25.
f. What effect, if any, would late timing of ESOs have on their expected time to exercise? Explain.
g. In what other ways have CEOs manipulated the value of their ESO awards?