Chapter 14 - Executive Compensation

Explain the difference between executive pay and pay for nonexecutives.

At the heart of most executive compensation plans is the idea that executives should be rewarded if the organization grows in profitability and value over a period of years. Because many executives are in high tax brackets, their compensation often is provided in ways that offer significant tax savings. Therefore, their total compensation packages are more significant than their base pay. Especially when the base salary is $1 million or more, the executive often is interested in the mix of items in the total package, including current and deferred compensation.

Executive compensation has both core and employee benefits elements, much like compensation packages for other employees. Includes: ???

Base pay Short-term incentives Long-term incentives Separation agreements Clawback provisions Employee benefits

Companies that use formal salary structures may use pay grades and ranges for all employees, except for the CEO. CEOs are not included in the pay structure because...

CEO's work is highly complex and unpredictable, and it is not possible to specify discrete responsibilities and duties and Setting CEO's compensation differs dramatically from the rational processes that compensation professionals use to build market-competitive pay structures

These plans pay additional monetary benefits and are designed to restore benefits under qualified plans

Enhanced Protection Program Benefits

Advantages to executives and the company from separation agreements:

Limit an executive's risk on occasion of unforeseen events Promote recruitment of talented executives Virtually eliminate an executive from making decisions to save his/her job at the expense of company welfare

Clarifies disclosure of companies to CEO and top executives Increase board of directors' accountability Companies need to file a wide variety of information, including executive compensation practices Tabular and narrative form of: - Stock option and appreciation rights - Long-term incentive plans - Pension plan Stock performance comparison - Compensation committee report Directors' compensation - Employment contracts and golden parachutes

Security Exchange Act

There are several laws and regulations that govern executive pay:

Security Exchange Act and Commission of 1934 Dodd-Frank Act

Define the characteristics of special groups and their importance to the organization.

Strategically important Positions tend to have built-in conflict - arises because of different factions place incompatible demands on members of this group

Fixed element of compensation Much smaller percentage of CEO pay CEO jobs do not fall within formal pay structure

base salary

Provides strategic decision making advice Represent shareholders' interests Usually 15 members CEOs and executives, Community leaders, Professionals Give final approval to recommendations Are compensated well for services, often, more than $50,000 annually plus a fee for each meeting attended

board of directors

allows board of directors to take back performance-based compensation when performance goals were not achieved These provisions are becoming more common because of increasing public scrutiny of executive compensation practices

clawback provisions

Outside directors usually membership majority Major duties include: - Review consultants' recommendations - Discuss assets and liabilities - Make final recommendations for proposals

compensation committees

awarded on an objective basis (company profits, financial condition, business conditions, company's future prospects)

discretionary incentives

Decisions regarding executive pay come down to three key players:

executive compensation consultants board of directors compensation committees

T or F: Most of the time, stock options are linked to executive performance.

false; Most of the time, stock options are not linked to executive performance.

separation agreements (golden parachutes)

giving executives pay and benefits following termination due to ownership change or corporate takeover through mergers or acquisitions

A 5% owner at any time during the year, or For the preceding year: Had compensation from the employer in excess of $120,000 in 2018, and was in the top-paid group of employees where top-paid employees are the top 20 percent most highly compensated employees

highly compensated employees

An officer having annual compensation greater than $175,000 in 2018, or An individual who for 2018 was either of the following: - A 5% owner of the company - A 1% owner having an annual compensation of more than $150,000

key employees

The Internal Revenue Code (I R C) recognizes two groups of employees who play a major role in a company's policy decisions:

key employees and highly compensated employees

comparing your compensation to others Executive salaries bear a consistent relative relationship to compensation of lower-level employees. Critics point out the gradual increase in the spread between executives' compensation and average salaries of people they employ.

social comparison theory

provide executive income at the end of a period, like restricted stock options Executives don't have to exercise this due to receive income

stock appreciation rights

increases the value of executives' estates bequeathed to designated beneficiaries (usually family members) upon their deaths, as well as provides executive with preferred tax treatments

supplemental life insurance

restores benefits restricted under qualified plans

supplemental retirement plans

ties bonuses to executives' performance (increases as performance increases)

target plan incentives

shareholders control executives' actions through compensation depicts employees as agents who enter an exchange with principals—the owners or their designated managers. Compensation is used as a controlling device à uses incentives to align the interests of the agent with the principal Mainly done through compensation package that is predominately based on stock options.

agency theory

There are several theoretical perspectives that try to explain the decisions that go into creating executive compensation, which are:

agency theory tournament theory social comparison theory

long-term incentives

equity agreement plans (deferred compensation plans): provide an executive with ownership stakes in the company Stock options: stocks purchased at a designated price for a specific time Employee stock purchase plans

Develop packages based on strategic analysis Recommends what the compensation packages should be Hired by the CEO Need to be included in public disclosure forms

executive compensation consultants

based on the attainment of specific performance criteria

performance-contingent incentives

Covers a broad range of benefits, from free lunches to the free use of corporate jets Company credit lines Company cars

perquisites

boards of directors promise to pay a bonuses in the value of company shares, or the increase in that value over a period of time These can be converted into real shares under two conditions Executives must be employed for a period of time Executives must retire from the company

phantom stock plans

based on a fixed formula (company profits as well)

predetermined allocation incentives

suggests managers compete for promotions if they want to make the most amount of money

tournament theory

T or F: Executive compensation packages emphasize long-term or deferred rewards over short-term rewards.

true

T or F: Short-term incentive plans play a major role in executive pay.

true

Requires four major provisions: - Say on pay vote - the right to vote yes or no on executive comp proposals - Independence requirements for compensation committee members and advisors - Disclosure of circumstances under which an executive would benefit from a golden parachute arrangement - Disclosure of the ratio of C E O pay to the median compensation of non-executive employees

Dodd-Frank Act

Why do pay committees recommend high amounts of pay?

The committee and board represent shareholder interests Executive compensation reflects changes in the market

Some argue that economic factors determine CEO compensation. The worth of CEOs should correspond closely to some measure of company success (profitability, sales, firm size) Tied to labor markets and competitor pay levels Studies have demonstrated that executive pay bears some relationship to company success, including the ability to make strategic changes and negotiate mergers or acquisitions successfully.

economic theory

what is executive status?

employees that include presidents of company, chief executive officers (CEOs), chief financial officers (CFOs), vice presidents, occasionally directors of the company, and other upper-level managers. Usually only those members of your most senior management team qualify for executive pay. It is usual the members of the "C-Suite."