Stock-based incentive contracts and managerial performance: the case of Ralston Purina Company

Under Ralston Purina Company's 1986 incentive contract 14 managers would re ceive $49.1 million in stock if within ten years the stock price closed abo ve $100 for ten consecutive days. While the contract required a 57.8% incre ase in stock price, it did not motivate managers to create value because th e rare of return required to reach $100 in ten years was substantially less than Ralston's cost of equity capital at the time of the contract's adopti on. Barring any action by managers that would substantially change the mark et's expectations about the firm, reaching the $100 hurdle price would be e asy. In fact, managers collected the contract's payoffs within five years d espite an industry-adjusted loss of $2.1 billion in shareholder value. (C) 1999 Elsevier Science S.A. All rights reserved.