Chapter 8 Flashcards
What is executive compensation?
governance mechanism that seeks to align the interests of managers, salaries, and bonuses and long-term incentive
What is executive compensation meant to do?
- attract talent
- retain talent
- motivate executive to create value for shareholders
What are the consequences of poorly structured exec compensation?
- dilutes incentives that serve shareholders
- distort incentives (focus on short-term earning)
what is the main determinant of CEO pay?
- explained and determined by the size of the company
what is optimal contracting?
Ceo pay is driven by competitive market forces
rent extraction
Ceo’s ability to exert influence over board and be paid at a higher level than competitive market forces –> usually lead by market failure
Who sets of exceutive compensation?
- compensation consultant
- compensation committee
- board of directors
- shareholders
what is the say on pay model
the ability of board of directors to have a say on the amount of pay CEO receives in the annual meeting
What is the compensation committee responsible for?
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
Why use a compensation consultant?
- 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
Peer-group compensation setting
-efficient and practical method and most benchmark CEO pay against a peer group of companies comparable in size, industry
Biggest drawback to benchmarking
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
Expected compensation
what is listed in the contract
earned compensation
what you actually receive –> usually less than what is expected
what is annual base pay
- fixed cash compensation and usuallyunder 1m always
over 1m happens usually through bonus
Bonus and performance
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)
Stock options (long term)
stock purchased at a designated price for a specific time
stock grants (long term)
a company offers stock to employees
exercise of stock grants (long term)
purchase of stock
disposition (long term(
sale of stock
fair market value (long term)
The stock price on the TSX
Vesting
how long till the option is yours
- deffered payoffs
stock price based
accounting based
strategic milestone based
maturity
how long do you have till you can exercise your right to purchase the stock?
non-statutory stock options
discounted stock prices and taxes are paid on the difference between discounted price and fair market value price
Restricted stocks
outright grant of shares (given) that are restricted in transferability and subject to vesting
- time based or performance based
stock appreciation rights
similar to restricted stocks but the ownder does not need to exercise stock rights to receive payment instead company gives out a bonus
Phantom stock
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
Stock ownership guidelines
executive is required to own a minimum stock and multiple of annual base salary
Hedging Restrictions
lock or limit change in value of vested shares
Pledging Restrictions
can not use shares as collateral for a loan or trading accounting
Clawbacks
tools to reduce agency cost
Golden parachute
entitled to compensation if a CEO is let go due to ownership of corporate takeover or change
Pro of Golden Parachute
- 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
Cons of Golden Parachute
- unlikley to prevent takeover
- not tied to performance
- they already well compensated
Platinum parachute
lucrative awards and continuation of company benefits usually given out to avoid legal problems and leaking of sensitive information
Clawback provision
takeback performance-based compensation when performance goals are not achieved
