Tangy Corporation is a young high-growth company engaged in the manufacture and distribution of automotive parts. Its common stock had doubled in value since the company was listed on the NASDAQ exchange about two years ago. Tangy currently has a high debt/equity ratio due to the issuance of debt to finance its capital expansion needs. Despite rapid growth in assets and profitability, Tangy has severe cash flow problems and a poor working capital ratio. The company urgently needs to attract new executives to the organization and to provide financial incentives to existing top management because of the recent turnover and high growth. Approximately 55% of the common stock is owned by Sam Tangy who is CEO, and his immediate family. None of the other officers own stock in the company.
Your group has been asked to prepare suggestions after reviewing the compensation system.
Your discussions with several top management individuals reveal the following aspects of the corporate strategy philosophy:
• The company needs to expand the equity capital base because of its concern for the high risk caused by large amounts of debt.
• Improvement in cash flow and liquidity would enhance its stock price and enable the company to continue its high growth rate.
• Top management feels that employees should own some stock in the company. The company currently offers a qualified pension plan to its employees and executives that provides only minimal pension benefits. No other deferred compensation or bonus arrangements are currently being offered.
• Sam Tangy feels that the top management group should own a substantial amount of Tangy stock to ensure that the interest of management correspond with the shareholder interests (i.e., the maximization of shareholder wealth).
The following four types of executive compensation arrangements have been discussed:
• Sec. 401 (k) and ESOP plans for employees.
• Encourage all employees and executives to independently fund their retirement needs beyond any Social Security benefits by establishing IRA plans.
• Provide restricted property arrangements (using Tangy stock) to attract new top level executives and to retain existing executive.
• Offer nonqualified or incentive stock options to existing and new executive.
Required: Prepare a client memo that recommends revisions to Tangy Corporation's existing compensation system for both its employees and executive groups. Your recommendations should discuss the pros and cons of different deferred compensation arrangements and should consider both tax and nontax factors.