Suppose the compensation committee for a corporation is preparing to hire a new CEO and debating which of two pay packages to offer. Package A includes an annual salary of $1 million plus 1000 shares of stock. Package B also has a salary of $1 million, but has 10,000 options to purchase the company at its current price of $50.

a) Draw a graph showing the relationship between the CEO’s total compensation (vertical axis) and the stock price (horizontal axis) for the two pay schemes. Clearly label the two compensation methods in your graph.

b) Discuss how a switch from the stock to stock option plan would alter CEO behavior.

c) Discuss how a switch from the stock to stock option plan would affect the type of CEO that would be willing to accept the job.