Session 3 - McCall - Executive compensation

Question 1

Outrage : a commonly reaction to executive compensation. The complaints seem to be about :

Answer 1

• The absolute amount
• The focus on international comparison differences used as justification
• The apparent insensitivity of pay to firm performance
• Perverse incentives

Question 2

Name the 9 elements of the complex combination that constitute the executive compensation

Answer 2

1. Cash, equity or in-kind
2. Current or deferred
3. Guaranteed and BoD-discretionary elements
4. Pay with near certainty or pay, which is at risk
5. Restricted shares or stock options
6. Signing or retaining bonuses
7. Perquisites
8. Loans at below-market rates
9. Gross-up payments to compensate for taxes

Question 3

Historical facts - Name the primary element that explains the rapid increase in executive pay and the widening gap between executives and their workers

Answer 3

The use of equity-based compensation has increased as well

Question 4

Academic contest over executive pay - There are 2 competing hypothesis :

Answer 4

1. Managerial power perspective : current executive pay results from the ability of management to effectively influence its own compensation, pay is excessive and dysfunctional in its compensation
2. Efficient contracting perspective : executive compensation is the result of optimal or efficient arm’s-length bargaining

Question 5

Managerial power perspective - Give examples on how management can influence the compensation

Answer 5

• It is in the devil of option grants (level of indexing, exercise pricing, taking risk out of option, …) : Research has established a systematic connection between options and the timing of corporate announcement that might influence share price. Rising stock prices will offer rewards while falling price impose no actual loss. Executives are encouraged to pursue risky strategies
• Equity-based compensation
• Pensions and severance agreements : overly generous, performance insensitive and largely hidden
• Bonuses : overly generous, open to management manipulation

Question 6

Efficient contracting perspective - What seeks the principle of efficient contracting ?

Answer 6

• To defend as ethically appropriate both the large amount and the composition of executive’s pay

Question 7

Efficient contracting perspective - Why implement it and what is the main question ?

Answer 7

• Large executive earnings are rational way to deal with motivating managers for a decreasing number of available positions. Monitoring performance of executive is hard, so it makes sense to use shares value as a proxy.
• But how much is necessary to motivate competition for executive positions.

Question 8

A broader ethical evaluation on executive compensation - Expression of outrage rely implicitly on 2 fundamental ethical considerations which are :

Answer 8

1. The common good : undermining employee morale, erode corporate credibility, weaken the trust of stakeholders, impacting society, social cohesiveness, …
2. Basic fairness : fair distribution of relative contribution and risk taking, the tasks and associated skill sets. It’s relative…

Question 9

Give a consequence on the fact that pay practice violates norms of basic fairness

Answer 9

It leads to a suspicion that the size of pay package is a function of the market that increasingly reflects a winner-takes-all approach