Executive Pay: The Plan

1
Executive Pay The Plan

• Video
• The What When Why of Executive Pay
• Components of Executive Pay
• The Take Home Message

2
The term Executive applies to(IRS Guidelines)

• 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
• Highly Paid Employees
• Owns ? 5 of the firm
• Earns ? 75K/year
• Earns ? 50K/year salary in top 20 of all
  employees

3
Do they deserve it?

• 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

4
Is Executive Pay Important? And if so, why?

• 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?

5
What are some of the components of Executive Pay?

• Current or Annual Pay
• Salary (lame, old, bureaucratic, non-performance
  pay)
• Bonuses (short-term performance base)
• Deferred Pay
• Stocks (long-term performance pay)
• Golden parachutes (separation pay)
• Fringe Compensation
• Benefits
• Perquisites

6
Current or Annual Pay Systems

• 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?

7
Current or Annual Pay Types of Bonuses

• 1. Discretionary Bonus
• Awarded on elective basis, for making
  exceptionally smart/strategic moves
• 2. Performance-contingent Bonus
• For attaining certain performance goals
• 3. Predetermined Allocation Bonus
• Based on formula and company profits
• 4. Target Plan Bonus
• Ties bonus to firm performance
• ? there are many types of bonuses and all of
  them are (or should be) performance-related

8
Current or Annual Pay
9
What are Deferred Pay Systems

• Rendering payment at a future date
• Main form of CEOs deferred pay
• Stocks Long-term incentives
• What does deferred pay supposed to do?
• 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

10
Deferred Pay Systems

• What is another advantage of using deferred pay?
• Provide tax advantages to CEOs
• How?
• 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 -gt income tax _at_
  39 2) exercise hold -gt capital gain _at_ 20

11
Deferred Pay Systems

• 1. Incentive Stock Options
• options to buy stocks (in the future) at
  discounted rates
• 2. Non-statutory Stock Options
• CEOs pay tax on the ?nce b/w the discounted price
  market price
• 3. Restricted Stocks
• CEOs get the stock, but not ownership (limited
  time frame)
• 4. Phantom Stocks
• Entrepreneurial firms, pre IPO

12
Deferred Pay Systems

• 5. Discount Stock Options
• Rates are far below market, pre-IPO, early stage
• 6. Stock Appreciation Rights
• Income is available only at the end of the
  designated period
• 7. Golden Parachute
• Pay benefits after retirement

13
Fringe Benefits

• Enhanced Protection Benefits
• Life insurance, health benefits, favorable tax
  treatments, retirement plans (tailored for the
  CEO)
• Perquisites Perks
• Company car, jet, financial legal
  planning/advice,
• Events meals, clothing, travel, tickets to
  events,
• Is it really necessary?

14
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