Executive Pay: The Plan Video s The What + When + Why of Executive Pay s Components of Executive Pay s The

Take Home Message

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The term Executive applies to:

(IRS Guidelines)
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Key Employees

One of 10 employees owning the largest % of the firm Owns 5% of the firm Earns more than $150K/year + owns 1% of firm Officers whose pay $45K/year are excluded Owns 5% of the firm Earns $75K/year Earns $50K/year & salary in top 20% of all employees

Highly Paid Employees

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Do they deserve it?

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Social/Ethical: do they deserve it?

Annual pay packages reach 8, 9, 10 digit figures McCaw (Cellular Comm., 1989): $54 million, while his company was losing money 1990: CEOs pay increased 17.4% = 3 times inflation rate or 3 times middle managers pay 1995: CEOs/Non-execs = 7/1 $ of CEOs / $ employees: 200/1 (US) vs. 17/1 (Japan) Example: $50K $10 million

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Is Executive Pay Important? And if so, why?

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Strategic Issues

CEOs set standards/examples for subordinates to follow (e.g., domino effect that starts with the CEO and ultimately impacts the entire workforce) Pay systems impact CEOs thinking, behaviors, & decision-making CEOs lead the whole organization Pay = Communication tool (i.e., the what & how of pay systems send a strong msg. to entire organization)

Why do executives get other incentive in addition to salaries?

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What are some of the components of Executive Pay?

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Current or Annual Pay:

Salary (lame, old, bureaucratic, non-performance pay) Bonuses (short-term performance base) Stocks (long-term performance pay) Golden parachutes (separation pay) Benefits Perquisites

Deferred Pay:

Fringe Compensation

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Current or Annual Pay Systems

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1. Salary: Base pay (just for showing up) Why do CEO jobs not fall within formal pay structures?

Work is highly complex& unpredictable; responsibilities are broad, high visibility

2. Bonuses: Pay-for-Performance (for achieving specific goals) How many types of bonuses are there? Examples?

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Current or Annual Pay: Types of Bonuses

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1. Discretionary Bonus:

Awarded on elective basis, for making exceptionally smart/strategic moves For attaining certain performance goals Based on formula and company profits Ties bonus to firm performance

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2. Performance-contingent Bonus:

3. Predetermined Allocation Bonus:

4. Target Plan Bonus:

= there are many types of bonuses and all of them are (or should be) performance-related
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Current or Annual Pay

Salary
$ = Fixed Unconditional Non-performance Very short-term Firm Size
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Bonuses
$ = Variable Contingent

Profit/Gain Shar.
$ = Variable Contingent

Financial-based Market-based Short-term Performance Short-term Performance

What are Deferred Pay Systems

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Rendering payment at a future date Main form of CEOs deferred pay:

Stocks = Long-term incentives Create a sense of ownership, aligning the interest of the CEO with those of the firm (shareholders) Why? B/c most CEOs are agents, not owners

What does deferred pay supposed to do?

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Deferred Pay Systems

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What is another advantage of using deferred pay?

Provide tax advantages to CEOs CEOs do not pay tax on payment until they receive it. Presumably, their income tax rates will be substantially lower during retirement, when their total income is at lower bracket Options: 1) exercise & sell -> income tax @ 39% 2) exercise & hold -> capital gain @ 20%

How?

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Deferred Pay Systems

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1. Incentive Stock Options:

options to buy stocks (in the future) at discounted rates CEOs pay tax on the nce b/w the discounted price & market price CEOs get the stock, but not ownership (limited time frame)

2. Non-statutory Stock Options:

3. Restricted Stocks:

4. Phantom Stocks:
Entrepreneurial firms, pre IPO

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Deferred Pay Systems

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5. Discount Stock Options:

Rates are far below market, pre-IPO, early stage Income is available only at the end of the designated period Pay & benefits after retirement

6. Stock Appreciation Rights:

7. Golden Parachute:

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Fringe Benefits
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Enhanced Protection Benefits:

Life insurance, health benefits, favorable tax treatments, retirement plans (tailored for the CEO) Company car, jet, financial & legal planning/advice, Events: meals, clothing, travel, tickets to events,

Perquisites = Perks:

Is it really necessary?

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The Take Home?

1 = Know that there are many types of deferred pay systems 2 = Try to understand why & when companies use stocks as incentives 3 = Know the advantages & disadvantages of stock options and other deferred payments 4 = Know some of the perks executives get (& employees dont) 5 = Size, not performance, is the strongest (not best) predictor of CEOs pay
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