smaller corporation has been in operation for several years. Each year , around the holidays, smaller gives cash bonus to each of its employees and Records the bonuses as compensation expense. Smaller has reached the point in which it is now making a reasonable return on its shareholders equity. At the end of the current year, the company president is considering establishing a compensatory share option plan for smaller key executives instead of paying cash bonuses to any of its employees. At this time, the market price and the planned option (excerise) price of the company's common stock are the same. The plan would allocate a specified number of options to each executive based on the executive level within the company and meeting smaller's targeted income goals. The service period would be 3 years and the options would have to be excerise within 10 years.

You are the controller for smaller and one of the key executives who would participate in the plan. You also already own a substantial number of shares of smaller common stock. The company president comes to you for advice about this plan and says, " if smaller establishes this plan, it will work out for all of us. It looks like the plan is pretty valuable, since an option pricing model shows a higher fair value for each option. The corporation will be saving cash because it won't have to pay bonuses to either executives or the other employees. But executives will manage ether because their share option pricing model shows a high fair value for each option will depend on meeting the company's targeted income. Because the market price and the option price are the same, there won't be any compensation cost or expense. This will increase its net income and earnings per share compared to last year, as well as it return on shareholders equity. So the stock value will go up. This seems like a win-win situation for everyone. Am I right on this? Do you think smaller should adopt this compensatory share option plan?

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From financial reporting and ethical perspectives, how would you reply to the president? please remember to quote your references