Chapter 8

Question 1

What is executive compensation?

Answer 1

governance mechanism that seeks to align the interests of managers, salaries, and bonuses and long-term incentive

Question 2

What is executive compensation meant to do?

Answer 2

1. attract talent
2. retain talent
3. motivate executive to create value for shareholders

Question 3

What are the consequences of poorly structured exec compensation?

Answer 3

• dilutes incentives that serve shareholders
• distort incentives (focus on short-term earning)

Question 4

what is the main determinant of CEO pay?

Answer 4

• explained and determined by the size of the company

Question 5

what is optimal contracting?

Answer 5

Ceo pay is driven by competitive market forces

Question 6

rent extraction

Answer 6

Ceo’s ability to exert influence over board and be paid at a higher level than competitive market forces –> usually lead by market failure

Question 7

Who sets of exceutive compensation?

Answer 7

• compensation consultant
• compensation committee
• board of directors
• shareholders

Question 8

what is the say on pay model

Answer 8

the ability of board of directors to have a say on the amount of pay CEO receives in the annual meeting

Question 9

What is the compensation committee responsible for?

Answer 9

independent directors on the board approve the compensation program
- assisted by HR and third-party compensation consultant

The right amount is the minimum amount it takes to attract a qualified individual

Question 10

Why use a compensation consultant?

Answer 10

• provides expertise and objectivity
• might be subject to conflict of interest and also sign of poor governance
• usually companies with compensation consultants have higher paid CEO

Question 11

Peer-group compensation setting

Answer 11

-efficient and practical method and most benchmark CEO pay against a peer group of companies comparable in size, industry

Question 12

Biggest drawback to benchmarking

Answer 12

Ratcheting effect: the median compensation tends to increase because if everyone is benchmarking then the benchmark inflates

• you don’t account for the CEO value added as much as the size of the company

but generally used to set competitive pay and inflate pay

Question 13

Expected compensation

Answer 13

what is listed in the contract

Question 14

earned compensation

Answer 14

what you actually receive –> usually less than what is expected

Question 15

what is annual base pay

Answer 15

• fixed cash compensation and usuallyunder 1m always

over 1m happens usually through bonus

Question 16

Bonus and performance

Answer 16

threshold performance: easy to acheive 80-95% chance of achieving

Target performance: more difficult to achieve 60% chance

maximum performance: levels are stretch goals and every difficult to achieve (10-15% chance of achievement)

Question 17

Stock options (long term)

Answer 17

stock purchased at a designated price for a specific time

Question 18

stock grants (long term)

Answer 18

a company offers stock to employees

Question 19

exercise of stock grants (long term)

Answer 19

purchase of stock

Question 20

disposition (long term(

Answer 20

sale of stock

Question 21

fair market value (long term)

Answer 21

The stock price on the TSX

Question 22

Vesting

Answer 22

how long till the option is yours
- deffered payoffs
stock price based
accounting based
strategic milestone based

Question 23

maturity

Answer 23

how long do you have till you can exercise your right to purchase the stock?

Question 24

non-statutory stock options

Answer 24

discounted stock prices and taxes are paid on the difference between discounted price and fair market value price

Question 25

Restricted stocks

Answer 25

outright grant of shares (given) that are restricted in transferability and subject to vesting
- time based or performance based

Question 26

stock appreciation rights

Answer 26

similar to restricted stocks but the ownder does not need to exercise stock rights to receive payment instead company gives out a bonus

Question 27

Phantom stock

Answer 27

bonus cash in the form of the equivalent of either the value of company shares or the increase in value over a period of time based on meeting two condition
- employed for many years
- executives must retire from the company

Question 28

Stock ownership guidelines

Answer 28

executive is required to own a minimum stock and multiple of annual base salary

Question 29

Hedging Restrictions

Answer 29

lock or limit change in value of vested shares

Question 30

Pledging Restrictions

Answer 30

can not use shares as collateral for a loan or trading accounting

Question 31

Clawbacks

Answer 31

tools to reduce agency cost

Question 32

Golden parachute

Answer 32

entitled to compensation if a CEO is let go due to ownership of corporate takeover or change

Question 33

Pro of Golden Parachute

Answer 33

• easier to hire someone new
• prevents CEO from acting in self-interest of saving their job
• gives execs a chance to work toward the interest of the shareholders in case of a takeover
• it increases the cost to the predator company

Question 34

Cons of Golden Parachute

Answer 34

• unlikley to prevent takeover
• not tied to performance
• they already well compensated

Question 35

Platinum parachute

Answer 35

lucrative awards and continuation of company benefits usually given out to avoid legal problems and leaking of sensitive information

Question 36

Clawback provision

Answer 36

takeback performance-based compensation when performance goals are not achieved