Chapter 11: Compensating Executives

Dodd-Frank Act

See Wall Street Reform and Consumer Protection Act of 2010.

Perks

See perquisites.

Restricted Stock Plans

a company may grant executives with stock options at market value or discounted value, or they may provide stock instead. Under restricted stock plans, executives do not have any ownership control over the disposition of the stock for a predetermined period, often many years. This predetermined period is known as the vesting period, much like vesting rights associated with employer-sponsored retirement plans.

Compensation Committee

a group that contains board of director members within and outside a company. Compensation committees review executive compensation consultants' alternate recommendations for compensation packages, discuss the assets and liabilities of the recommendations, and recommend the consultant's best proposal to the board of directors for its consideration.

Non-statutory Stock Options

a kind of executive deferred compensation, entitle executives to purchase their companies' stock in the future at a predetermined price. The predetermined price usually equals the stock price at the time an executive receives the stock options. Nonstatutory stock options do not entitle executives to favorable tax treatment.

Phantom Stock

a type of executive deferred compensation, is an arrangement whereby boards of directors compensate executives with hypothetical company stock rather than actual shares of company stock. Phantom stock plans are similar to restricted stock plans because executives must meet specific conditions before they can convert these phantom shares into real shares of company stock.

Stock Appreciation Rights

a type of executive deferred compensation, provide executives income at the end of a designated period, much like restricted stock options; however, executives never have to exercise their stock rights to receive income. The company simply awards payment to executives based on the difference in stock price between the time the company granted the stock rights at fair market value to the end of the designated period, permitting the executives to keep the stock.

Securities Exchange Act of 1934

applies to the disclosure of executive compensation.

Discretionary Bonuses

are awarded to executives on an elective basis by boards of directors. Boards of directors weigh four factors in determining discretionary bonus amounts: company profits, the financial condition of the company, business conditions, and prospects for the future.

Perquisites

are benefits offered exclusively to executives (e.g., country club memberships).

Platinum Parachutes

are lucrative awards that compensate departing executives with severance pay, continuation of company benefits, and even stock options.

Clawback Provisions

are provisions in CEO employment contracts that allow boards of directors to take back performance-based compensation if they were to subsequently learn that performance goals were not actually achieved, regardless of whether the CEO was responsible for performance falling short of target levels.

Restricted Stock Units

are shares of company stock that are awarded to executives at the end of the restriction period.

Named Executive Officers (NEO)

are the four most highly compensated after the CEO, and detailed information about their compensation must be disclosed in the definitive proxy statement DEF 14A.

Key Employee

as defined by the Internal Revenue Service (IRS), includes any employee who, during the current year, is an officer of the employer having an annual pay of more than $175,000, or an individual who for 2018 was either of the following: a 5 percent owner of the employer's business or a 1 percent owner of the employer's business whose annual pay was more than $150,000. These dollar amounts are indexed for inflation in increments of $5,000.

Performance-Contingent Bonuses

awarded to executives, are based on the attainment of such specific performance criteria as market share.

Predetermined Allocation Bonuses

awarded to executives, is based on a fixed formula. Company profits are often the main determinant of the bonus amounts.

Target Plan Bonuses

awarded to executives, is based on executives' performance. Executives do not receive bonuses unless their performance exceeds minimally acceptable standards.

Definitive Proxy Statement

companies must file this statement under Section 14a of the Securities Exchange Act. This statement is typically referred to as a DEF 14A, revealing detailed information about the compensation of the chief executive officer (CEO) and named executive officers (NEOs), who are the four most highly compensated executives after the CEO. Within the DEF 14A, companies must disclose multiple types of information about compensation. This information should be presented in narrative and tabular form. The narrative is referred to as the Compensation Discussion & Analysis (CD&A) and it must present an unambiguous explanation of all executive compensation information contained in the tables.

Compensation Discussion and Analysis (CD&A)

contained within the definitive proxy statement (DEF 14A), must present an unambiguous explanation of all executive compensation information contained in the tables.

Agency Problem

describes an executive's behavior that promotes his or her self-interests rather than the interests of the company owners or shareholders.

Wall Street Reform and Consumer Protection Act of 2010

enhances the transparency of executive compensation practices. Also commonly referred to as the Dodd-Frank Act.

Incentive Stock Options

entitle executives to purchase their companies' stock in the future at a predetermined price. The predetermined price usually equals the stock price at the time an executive receives the stock options. Incentive stock options entitle executives to favorable tax treatment.

Golden Parachutes

executive deferred compensation that provides pay and benefits to executives following their termination resulting from a change in ownership or corporate takeover.

Say on Pay

gives company shareholders the right to vote yes or no on executive compensation proposals, including current and deferred components, including golden parachute agreements, at least once every 3 years. Although the say on pay provision guarantees shareholders the right to vote on executive compensation proposals, the vote is nonbinding.

Securities and Exchange Commission (SEC)

is a nonpartisan, quasi-judicial federal government agency with responsibility for administering federal securities laws.

Highly Compensated Employee

is defined by the Internal Revenue Service as an officer. The term key 'employee' means any employee who at any time during the year is an officer having annual pay of more than $175,000, OR an individual who for 2018 was either of the following: a 5 percent owner of the employer's business or a 1 percent owner of the employer's business whose annual pay was more than $150,000.

Sarbanes-Oxley Act of 2002

mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures, and combat corporate and accounting fraud in response to corporate accounting scandals in Enron, Tyco, and other large U.S. corporations. The act established the Public Company Accounting Oversight Board (PCAOB) to oversee the activities of the auditing profession.

Supplemental Retirement Plans

offered to executives, are designed to restore benefits restricted under qualified plans.

Executive Compensation Consultants

propose recommendations to chief executive officers and board of director members for alternate executive compensation packages.

Supplemental Life Insurance

protection represents additional life insurance offered exclusively to executives. Companies design executives' supplemental life insurance protection to increase the value of executives' estates, bequeathed to designated beneficiaries (usually family members) upon their death, and to provide greater benefits than standard plans usually allow.

Tournament Theory

provides an explanation for executive compensation determination based on substantially greater competition for high-ranking jobs. Lucrative chief executive compensation packages represent the prize to those who win the competition by becoming chief executives.

Social Comparison Theory

provides an explanation for executive compensation determination based on the tendency for the board of directors to offer executive compensation packages that are similar to those in peer companies.

Agency Theory

provides an explanation of executive compensation determination based on the relationship between company owners (shareholders) and agents (executives).

Separation Agreements

refer to a type of deferred compensation which guarantees that an executive will receive a lucrative compensation package upon employment termination.

Equity Plans

refers to a type of deferred compensation that is designed to provide an executive with an ownership stake in the company through a variety of mechanisms, including stock plans.

Performance Plan

refers to a type of equity agreement whereby a company's board of directors establishes performance criteria that an executive must meet before receiving a reward of stocks or stock options.

Deferred Compensation

refers to an agreement between an employee and a company to render payments to an employee at a future date. Deferred compensation is a hallmark of executive compensation packages.

Capital Gains

refers to the difference between the company stock price at the time of purchase and the lower stock price at the time an executive receives the stock options when the stock price at disposition is higher.

Capital Loss

refers to the difference between the company stock price at the time of purchase and the lower stock price at the time an executive receives the stock options when the stock price at disposition is lower.

Offering Period

refers to the span in time over which employees, including executives, may purchase the employer's stock based on the money set aside in their accounts established through payroll deduction.

Company Stock Shares

represent equity segments of equal value. Equity interest increases with the number of stock shares held.

Board of Directors

represents shareholders' interests by weighing the pros and cons of top executives' decisions. Members include chief executive officers and top executives of other successful companies, distinguished community leaders, well-regarded professionals (e.g., physicians and attorneys), and a few of the company's top-level executives.

Company Stock

represents the total equity or worth of the company.