(Incentive compensation) According to a news article, the chairman of HCA- Hospital Corporation of America, Thomas Frist, received $127 million in com¬ pensation for 1992. Of that amount, $125.9 million came from exercising stock options that had been received in 1989. According to the same article, many of the other HCA top managers also exercised substantial amounts of stock options in 1992. The stock options gave the officers the right to purchase the stock from the corporation for a price that was substantially below the market value.

One of the reasons cited by the managers for exercising the stock options in 1992 was an expectation that tax laws were going to change. Specifically, the managers expected two tax law changes to be enacted in 1993 or later years: 1. An increase in the tax rate on personal income. 2. A limit of $1,000,000 on the annual amount of compensation paid to top executives that would be deductible for tax purposes by corporations.

[SOURCE: Helene Cooper, “HCA Chairman’s 1992 Compensation Hit $127 Million Due to Stock Options,” Wall Street Journal (March 24, 1993), p. B7. Reprinted by permission of The Wall Street Journal, © 1993 Dow Jones & Company, Inc. All Rights Reserved Worldwide.]

a. Were the stock options exercised in 1992 compensation for job performance in 1992 or compensation for other years? Explain.

b. If the tax law changes expected by the managers were passed as anticipated, was exercising the stock options a wise move for the managers? For HCA? Explain.

c. For 1992, HCA’s net income was $28.1 million. Given the level of compen¬ sation received by Mr. Frist for 1992, does Mr. Frist’s pay appear to be equitable? Explain.

d. If Mr. Frist and the other top managers had not only exercised their stock options, but also sold their stock in 1992, how would this have potentially affected their incentives?

1024 PAJRT VII Performance Evaluation