Talked about all sorts of pricing strategies – very cool stuff. The optimal one (from the firm’s perspective) seems to be 2 part tariff, which is having a “membership” fee and then a minimal usage fee. Examples: student advantage cards, golf club memberships with tee fees; printers with subsequent cartridge purchases; basic telephone service with per minute charges, etc. In simplified terms, once you’ve purchased the “membership” part, you will spend more on the usage charges than you otherwise would have, since the more expensive part is already spent and you feel the need to “amortize” the cost. There is a much more technical and correct explanation for this. The bottom line – this is something I can use directly on my job right now!
The final accounting lecture was devoted to accounting of employee stock options. Apparently, these are not accounted for as compensation expense at all. Since they are granted with strike price equal to current market price, they are stated as having 0 value. True, the intrinsic value (e.g., what you could get if you sold them right away) is $0, but since they usually have long time horizons (usually, 10 years), the time value is huge. Still, in the mid to late nineties they did not figure on the balance sheet or income statements at all. As the companies’ valuations went up, so did the value of those older stock options, but no one cared. Finally, in the past few years, these options started catching up. The companies’ valuations have come down quite a bit, but are still often higher than they were 5 or 10 years ago, leading to some fat stock options outstanding for companies like Oracle and Microsoft. Recently, Microsoft has had to go out to the open market to buy stock at $30/share to fulfill the employees’ stock option redemptions averaging at $9/share. Even more problematic, this sudden expense and associated cash outflow have no matching event – this is really a kind of deferred compensation from the late nineties. Fortunately, this information is finally available fully in the financial statements’ footnotes, but only the Wharton-trained accountants are going to go hunting for it ;)
We then started thinking about the ways the situation could be improved, ignoring the political ramifications, the software lobby, etc. The problem is really difficult, since the value of those stock options is really difficult to estimate and the standard Black-Scholes model is not suitable, given that 1) the options cannot be sold on the open market, 2) they have a vesting period, and are for much longer time periods than the typical Black-Scholes applications. Fascinating discussion, but I have probably already bored most of the readers.
At the end of class the professor (it’s her first time teaching the exec MBA class) thanked us for keeping the class discussions lively, wished us luck on the final exam, and passed out the class review forms. Appreciative applause followed.
Final Econ Lecture
The final econ lecture was devoted to risk. When does it make sense to take insurance? This soon evolved into a discussion about universal health insurance and the trial lawyers. Asymmetric information, shirking, moral hazard – all having some political connotations and interesting examples.
At the end of class the professor (it’s his 20th exec MBA class) told us how one of the students 20 years ago asked him over beers what does the micro-econ class really teaches you, if you forget all the formulas the day you hand in your final exam. He presented us with his answer: 1) emphasis on substitution, 2) constrained optimization, making sure that marginal cost equals marginal revenue, 3) the statics of supply and demand, 4) the importance of market structure (monopoly versus competition), and, finally, 5) the appreciation of the fact market systems usually work well if left to their own devices, however, in select cases careful regulation might be good.
He then thanked the teaching assistant and bowed out with John Lennon’s words: “I’d like to thank you on behalf of the band and myself and I hope we passed the audition”. The contrast between this closing and the one four hours earlier was evident in the sincerity and duration of the applause.