«Project paper - Abnormal Earnings Model Valuation» - Great Essay Sample

Introduction

The abnormal earnings model is a method that determines an organization’s worth using earnings and book value. The method looks whether the decisions of the management will make an organization perform worse or better than projected. The model suggests that investors need to pay more than the book value in case earnings are higher than projected; otherwise, investors pay less than the book value in case earnings are lower than projected.

From the Beneish score for Oakleys, it is apparent that the score is -1.9832. This score is greater than -2.22, which is an indication that there is a high probability of manipulating the company’s earnings. This calls for a further inspection of the company and its subsidiaries in order to discover the areas, where earnings have been manipulated. The companies must be manipulating stock at hand or the recognition of revenue in order to have  remarkably high earnings.

Abnormal earnings as an approach of valuation determine the worth of an entity on the basis of book value and subsequent earnings. Comparing the hypothetical share price arrived at using the Abnormal Earnings Model and the actual share price, it is apparent that the actual share price is lower than the hypothetical value obtained using the abnormal earnings approach. The earnings are; therefore, lower than projected in the companies. This indicates a high level of earnings manipulation. In this case, investors will have to suffer. Since the expected earnings are exceedingly lower than projected, investors will require to pay more than the book value recordings in order to facilitate operations of the companies. Without the facilitation of investors, the companies may stop existing as going concerns since the projected earnings are lower than the real earnings. Besides, the two companies may end up closing business as a result of earnings manipulation, which may draw investors away from the entities. Withdrawal of investors is likely to come from the dissatisfaction, which is likely to be generated by a lower real earning than expected. Investors are usually interested in companies that have real earnings being remarkably high. The moment investors notice that a company manipulates its earnings in order to depict high performance, they withdraw their investment with the company since their chief objective is to benefit from the earnings of the organization. Their withdrawal is an indication of dissatisfaction with the organization. According to the indications of the model, the decision of management to manipulate earnings of the companies will cause organizations to perform worse than projected. This emanates from the fact that, the actual share price is lower than the hypothetical value obtained by the abnormal earnings approach of valuation.

From the DEF 14 filing, the proxy statement indicates the compensation for CEOs. According to the SEC filing, there are usually three components regarding the compensation of CEOs. These entail long term incentive, salary and annual incentive compensations. The salary of CEOs in recent years need to have an increase of 4%. The salary compensation for CEOs is; therefore, 35% - 45% of the growth in share earnings. Besides, according to the provisions, annual incentive compensation for CEOs does not comprise of discretionary cash bonuses, which are awarded annually. This is; therefore, not on the ground of attaining personal and organizational targets; the specific bonus received by CEOs does not depend on the performance of the CEO. CEOs usually receive compensation based on the gain on share earnings. Further, the SEC filing provides that CEOs are granted stock options as part of long term incentive compensation.

In compensating the CEO, the board of directors uses gains in share earnings. The gains in share earnings compensate CEOs for the annual incentive compensation. The CEOs should receive a third of the amount of bonus. Besides, the salary compensation for CEOs is influenced by the long term growth of share earnings. Therefore, the board of directors uses share earnings as the chief vehicle for compensation. On the other hand, the board of directors uses stock options as a chief vehicle for long term incentive compensation. Using the three vehicles, the board of directors is capable of fully compensating the CEOs.

Accounting is a critical requirement in any organization. It assists in coming up with a budget projection and formulate on how the expectations can be met. Accounting is constantly used by organizations in evaluating various aspects and operations of the organization. In evaluating the performance of CEO, accounting has to be used. For instance, in evaluating the performance of a CEO, accounting is used, where various performance indicators become evaluated using an accounting approach. Therefore, accounting is a critical approach used by organizations in evaluating CEOs. Without the use of accounting in the evaluation of the CEO, an organization will not be capable of knowing whether it is facing cost benefit or experiencing losses. In addition, according to the SEC filing, the use of accounting is a crucial aspect in evaluating the reasonable remuneration and compensation that CEOs should receive. In this case, the calculation of percentages is critical, which depends on the accounted budget. Hence, accounting needs to be applied.

According to the SEC filing, stock options are available to insiders, but the amount of stock ownership depends on the position and performance of insiders. The company insiders may own a third of the company. However, this depends with the company ownership. In case it is a private company, the ownership is chiefly under the pioneers of the company since they own the entire company.