Executive Compensation Flashcards
Four Behavioral Biases common to the Executive Compensation Landscape
Overconfidence
Status Quo
Home country
Endowment
The tendency to
overestimate or
exaggerate one’s ability to
successfully perform a given task
Overconfidence
Because executives generally have access
to greater inside knowledge of an individual
firm, they tend to overrate their abilities and
overvalue company holdings
Increased choices
and
information generally lead to
greater indecision
Status quo
The scientific principle of inertia ; Corporate executives often avoid making changes, instead selecting the option that keeps conditions the same
The tendency to
favor companies in one’s own
country over those from other
regions and countries
With wealth heavily concentrated in
company stock , executives may not
realize their allocation could be negatively
impacting portfolio diversification
Tendency to give
holdings that
are owned a disproportionate
value because they are already
owned vs. purchasing outright
Endowment
Executives may hold onto inappropriate
assets that they otherwise would not
buy (or own) if they didn’t already hold them
What percent of executive compensation in the money options are allowed to expire every year?
11%
What company constraints get in the way of executive compensation being leveraged?
Imposed lock ups
Limited trading
windows
Company mandates
What information processing challenges get in the way of executive compensation being leveraged?
Infrequent reporting
Confusing plan documents
Tax ramifications
What investor challenges get in the way of executive compensation being leveraged?
Lack of coordination
Concentration risk
Procrastination
Access to qualified
advice
What are three discovery questions for executives that deal with emotional challenges related to concentrated positions in their employer stock?
If you didn’t work at your current company, how much of the stock would you own in
your portfolio?
What would be more disturbing: selling a security that continues to rise or holding one
that continues to fall?
If you were presented with cash equal to the value of your current position, how much
would you allocate to your company stock?
What is idiosyncratic or nonsystemic risk?
Security-specific risk- risk associated with owning any specific risk
Cam be managed through diversification
What are three discovery questions for executives that deal with emotional challenges related to concentrated positions in their employer stock?
What is your primary objective for these assets (tax minimization, appreciation, risk
reduction)?
What will these assets be used for in your financial plan (retirement, business,
charitable)?
What is your view of your company stock why?
How do you see your role in your company changing?
What is your view on the direction of tax rates?
Describe your exit strategy for these positions?
Why employers offer executive compensation plans
Attract, retain, motivate high-value employees
Reduce out-of-pocket compensation costs
Link company performance to employee compensation
Provide pride of ownership to employees
Indicates the time at which one has full control of the award
vesting schedule
Why are employees interested in executive compensation plans?
Build wealth
Participate in company growth
Greater control of finances
Vesting schedule when 100% vests on a single date
cliff vesting
