chapter 15 special compensation situations harcourt, inc. items and derived items copyright © 2001...

Chapter 15Chapter 15Special Compensation SituationsSpecial Compensation Situations

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of thework should be mailed to the following address: Permissions Department,Harcourt, Inc., 6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Compensation Compensation Decision Making Decision Making

Bergmann & ScarpelloBergmann & Scarpello4th edition4th edition

Harcourt, Inc. items and deriveditems copyright © 2001 by Harcourt, Inc.

Executive Compensation Executive Compensation (1990-95)(1990-95)

0

20

40

60

80

100

Percentage Increase 92 75 16 39

CEO Pay Corp.ProfitsEmployee

PayWorker Layoff


Pay in Large FirmsPay in Large Firms

1980

1998

Blue Collar : CEO 1:42

Blue Collar : CEO 1:419 (see latest data)


Executive CompensationExecutive Compensation

• Median total compensation, 2005, $6.0m, up 16% from 2004 (includes salary, bonuses, value of restricted stock at time of grant, gains from options exercises, other long-term incentives)– Median base pay up 3.6%, bonuses up 8.4%, median salary

and bonus $2.4m (profits up 13%, median total shareholder return [stock-price appreciation plus reinvested dividends] up 6.8%)

• CEOs of best-performing companies in terms of total shareholder returns received greater rewards

• Median gain from options exercised: $3.2m• Median unrealized gains from options $11.8m

– Options usage likely to decline given pending requirements to expense

– By comparison, nonunion salaried Ees’ compensation up 3.4%

» Source: Wall Street Journal, 4/11/05, based on analysis of 350 major U.S. corporations by Mercer HR Consulting


• CEO

• Talent competition

• Position’s importance

• Changing skill requirements

• CEO willingness to switch companies

• CEO willingness to bargain

• Stock & incentives

• Average

Worker

• Increased labor supply

• Shift from manufacturing to

service

• Decline of union power

• Technological change

• Increased global

competition


Beliefs Guiding the Design of Beliefs Guiding the Design of Executive Compensation PlansExecutive Compensation Plans

• Must influence behaviors that increase firm value for the stockholder

• Should focus on business unit AND corporate results

• May influence corporate culture and values

• Must recognize skepticism as legitimate


Competitive BenchmarkingCompetitive Benchmarking

• Most companies historically have benchmarked executive compensation– Practice tends to inflate compensation

• If all orgs seek to pay median or above, median will inevitably rise (see Business Week Commentary, “The Artificial Sweetener in CEO Pay” on website)

– Practice tends to disregard relationship between pay and company performance

– Some movement to tie pay to performance of peer group

» Source: Wall Street Journal, 4/12/04

• In 1960, CEOs earned average of 2x as much as president of U.S.; today, 30x

» Source: Wall Street Journal, 7/19/05, 1/21/06


International ComparisonsInternational Comparisons

• Median salary plus cash bonus for U.S. CEOs in office at least one year was $2.3m in 2004, according to analysis by Boardex of London– U.K.: $1.2m– France: $857k– Sweden: $386k

• Pay gap between U.S. and Asian CEOs even larger, according to analysis by Mercer – Japan: $318k– Hong Kong: $302k– Singapore: $263k– India: $88k


• Average CEO’s salary in U.S. is 475x average ee’s salary, cf. 11x in Japan, 15x in France, 20x in Canada, 22x in U.K.



Putting a Ceiling on PayPutting a Ceiling on Pay

• Growing number of shareholder activists pushing Cos to establish maximum ratios between what their executives earn and what their average- or lowest-paid workers earn

• Average CEO in U.S. earned 282x salary of average worker in 2002, cf. 42x in 1982– Whole Foods Market (leading organic food retailer) limits

any executive’s pay to no more than 14x pay of average worker (current cap is $409k)

– Ben & Jerry’s had capped pay at 7x pay of lowest worker, but dropped policy in 1994

– Herman Miller had capped pay at 20x, but dropped policy in 1996

• Critics argue that such practices that exclude stock options are of little value



““Cost-Cutting Airlines Grapple Cost-Cutting Airlines Grapple With Issue of Executive Pay”With Issue of Executive Pay”

• CEOs of Delta and AMR forced out partly due to union displeasure over executive sacrifices perceived as inadequate– Further curbs on executive compensation,

however, could increase turnover• “If you pay below market, you get what you pay

for”• At US Airways, middle and senior management

turnover increased 50% from 2003 to 2004» Source: Wall Street Journal, 1/25/05

OrganizationalGoals

ExecutiveGoals

ExecutiveGoals

OrganizationalGoals

AgencyTheory



Components of Executive Components of Executive Officers’ PayOfficers’ Pay

• Base Pay

• Annual Incentive

• Long-term Incentive

• Perks

• BenefitsTrend: Base pay in percentage of total

Variable pay in percentage of total


Perks on the Decline?Perks on the Decline?

• 18% of top officers received company car in 2002, down from 56% in 1998

• 8% received country club membership, down from 54% in 1998

• 3% received health club membership, down from 23% in 1998

• 2% received sports/theater tickets, down from 46% in 1998



Long-Term IncentivesLong-Term Incentives

• Stock option:Stock option: right granted an executive to purchase stock at a fixed price over a fixed period of time– Incentive stock options (no taxes at grant or exercise

for Ee, no deduction as expense for Co)– Nonqualified options (do not have restrictions such

as minimum holding time or price requirements; taxed as ordinary income at exercise [on difference between exercise price and fair market value at time of exercise], Co may deduct)



• Stock purchase plans:Stock purchase plans: allow a short time to exercise purchase rights at a set price

• Restricted stock:Restricted stock: the outright grant of stock to an executive at no or very low cost but subject to restrictions– Phantom stock (“units” granted that can be

cashed in)– Performance-accelerated restricted stock

(shares earned earlier if performance targets met)



• Performance-based goal attainment plans: Performance-based goal attainment plans: provide the executive a number of units or provide the executive a number of units or shares of stock if predetermined long-term shares of stock if predetermined long-term goals are met within a specified time periodgoals are met within a specified time period– Formula value grants (value based on formula)– Formula value appreciation grants (value based on

appreciation of unit over period)– Full-value grants (full value, not appreciation)– Dividend units grants (dividend entitlement)

Embryonic Stage: lucrative stock incentives

Growth Stage: increasedbase salary & annual cashincentives

Mature Stage: short-term performance-based plans

Decline Stage: base salary

Executive Incentives & Strategic Management


Golden parachute: designedGolden parachute: designedto protect a displaced executiveto protect a displaced executive

after a takeover after a takeover



Problems in Executive Problems in Executive Compensation DesignCompensation Design

• Need to maintain external market equity may lead to continuous increase of incentives, possibly without positive impact

• Not keeping in sync with life cycle of firm may result in an inappropriate mix

• Limited financial indicators may result in emphasis on short-term goals, ignoring long-term success

• Overuse of stocks may result in ownership dilution


Problems in Executive Problems in Executive Compensation DesignCompensation Design

• Risk removal--plan revision to accommodate changes--may send the wrong message

• Executives may exercise options & earn huge sums even when firm does poorly

• Letting tax & accounting considerations dictate plans may not be best for firm

Public distrust may be reduced IF the firm Public distrust may be reduced IF the firm explains AND IF the press cooperates explains AND IF the press cooperates (proxies & annual reports may work best)(proxies & annual reports may work best)


Report: Workers Want Vastly Report: Workers Want Vastly Different RewardsDifferent Rewards

• More than half of those surveyed agree that quality of Co’s recognition efforts affects how they perform their job, w/ only 10% completely satisfied w/ their Co’s rewards program– 70% receive verbal praise, but only 49% want it– 40% who want written praise receive it– 30% who want to be singled out thru special event are recognized

that way– 29% who want cash bonus as recognition for their work receive it– 27% who want incentives such as award merchandise, gift cards,

or trips receive them– 27% who want award such as trophy or plaque receive it

• “This study shows Ees are motivated in vastly different ways and Cos still have a long way to go to ensure their Ees feel valued”– 64% said their Co should offer greater choice of workplace rewards

when it comes to recognizing efforts


Report: Workers Want Vastly Report: Workers Want Vastly Different RewardsDifferent Rewards

• Reducing Ee turnover and becoming an Er of choice are two of most pressing concerns Cos have today

• Compared to Ees unsatisfied w/ their Ee recognition program, Ees who are completely satisfied with it are:– 11x as likely to be satisfied w/ job– 7x as likely to spend careers w/ Co– 7x as likely to recommend their org to others– 6x as likely to invest $ in their Co if they could– 5x as likely to feel highly valued at work

• One way to add freshness and enthusiasm is by forming advisory panel of people from different job levels and parts of Co

» Source: HRNews Online, 2/8/06


International CompensationInternational Compensation

WHO

Expatriates

Third-countryNationals

Local-countryNationals

WHAT

Base Salary

Employee benefits

Equalization benefits

Incentives


International International CompensationCompensation

Base Salary

Home-based Calculated using the salary structureand policies of the parent organization

Host-based Calculated using the practices and policies of the country in which thesubsidiary is located

Better of Home or Host

Pays employees the highest of the twolocations

International

Ties the pay of the employees to acommon reference point; pay & benefits remain relatively equivalent regardless of employees’ locations



Employee Benefits

For ExpatriatesCovered by parent companybenefit package

For TCNs May need a separate floatingbenefit plan

For LCNs Must carefully review localpractices, customs, & laws



Equalization Benefits

Primarily for expatriates (and sometimes TCN’s)--meant to reduce negative effects of living abroad• Round-trip air fares• Private schooling for children• Subsidies for living expenses• House or apartment• Relief for taxation



Incentives

Trends: • Increased use of incentives, long & short term• Focus on performance measured at the strategic business unit• Attention to tax considerations• Overall reduction in the use of expatriates


Expatriate CompensationExpatriate Compensation

• More Ers trying to hold line on expatriate-pay costs– Expats sent to Europe or North America

seeing foreign-service premiums reduced

• U.S. is #1 expat location, followed by United Kingdom, China, Singapore


% OF FIRMS % OF FIRMS OFFERING OFFERINGTYPICALLY SOMETIMES

Household goods shipment and storage 94% 5% Temporary living expenses 92 7 Housing allowance 90 10 Tax briefing 88 10 Goods and services allowance 83 16 Home leave 82 15 Destination/settling in assistance 78 16 Familiarization trip 74 23 School fees 71 23 Repatriation briefings 57 30 Assignment premium/foreign-service allowance 52 16 Home country car sale/loss 52 20 Nonaccompanying dependent visits 51 31 Spousal assistance 42 36 Hardship allowance 39 43 Language training 37 54 Home disposition 34 27Intercultural training 28 56



IssuesIssues Causing the Loss of Causing the Loss of Employees after repatriationEmployees after repatriation

• Unrealistic expectations on the part of both parties

• Poor career management when the expatriate is on assignment

• Poorly designed programs for repatriation

• More than 50% of returning expatriates leave their Co within one year


Board of Directors’ CompensationBoard of Directors’ Compensation

AnnualRetainer

BoardMeeting Fees

CommitteeMeeting Fees

StockOptions

RestrictedStock Grants

RestrictedStock Options

LifeInsurance Pensions

Etc.

StockGrants


Director CompensationDirector Compensation

• In effort to recruit and retain higher-caliber directors, cos are raising board members’ cash pay– Executive recruiters report one in eight director candidates pursued

accept seat, down from one in four five years ago– 80% of surveyed cos have increased or plan to increase cash

compensation– Median case retainer: $35,500– Audit and compensation committee heads now typically receiving

additional compensation, given responsibilities resulting from Sarbannes-Oxley

• Structure of compensation packages also changing– Stock options falling out of favor– 11% of companies have board stock-ownership guidelines, up from

8% in 1998• Director position is part-time, typically ~200 hrs/yr (but

increasing)• Average compensation, 2001: $152k



Two-Tier Pay PlansTwo-Tier Pay Plans

• Recent two-tier agreements– Delphi, Visteon/UAW– Caterpillar/UAW– S. Cal grocery ers/UFCW

• Workers on lower tier have more negative attitudes– Effects of permanent and temporary plans differ– Perceived employment mobility moderates

attitudes• Low mobility workers had more positive attitudes than

high mobility» Source: Townsend and Partridge (1999)


Skill-Based CompensationSkill-Based Compensation

Traditional Traditional Approach Approach

to Payto Pay

Job-based:Job-based: Pay is assigned to a position through formal job analysis & evaluation (the relative value of a job)

Person-based:Person-based: Individual pay is based on the knowledge or the number & kind of skills the employee is capable of applying within the organization

Skill orSkill orKnowledge-Knowledge-

BasedBasedPayPay


Skill-Based CompensationSkill-Based CompensationAdvantagesAdvantages

• Increased flexibility in making job assignments

• Fewer job classifications

• Lower staffing levels

• Reduced absenteeism & turnover

• Improved recruitment

• Support for team approach


Skill-Based CompensationSkill-Based CompensationDisadvantagesDisadvantages

• Potential increase in direct wage cost• Time & resources required for training• Presence of employees unwilling or unable to

add to their skills• Loss of productivity• Instances of employees “topping out”• Employee disillusionment over skill nonuse • Eight to ten skill limit


Competency-Based Competency-Based CompensationCompensation

• Usually addition to, not replacement for traditional job-based pay

• Competencies:Competencies: demonstrable characteristics of the person, including knowledge, skills, and behaviors, that enable performance

• Broadens the concept of paying for skills and knowledge to include more cognitive-based activities


Rising Interest due to Rising Interest due to Changing AttitudesChanging Attitudes

• Job-based valuing of activities may not be relevant to the current organizational situation

• Organizations with successful nonexempt skill-based plans may want to expand to the exempt jobs

• Competency-based compensation aligns the compensation program to the competencies the workforce needs to enable organizations to compete in a dynamic or hostile marketplace


COMMONLYCOMMONLY USED USED COMPETENCIESCOMPETENCIES

• Customer Orientation• Leadership• Teamwork• Communication• Adaptability• Innovation• Problem-solving• Influence• Analytical Thinking

• Initiative• Quality Orientation• Results Orientation• Technical Expertise• Creativity• Achievement• Decision-making• Flexibility• Business Orientation• see dmp 3/03 EHRA

A Model for A Model for Competency Competency Selection & DefinitionSelection & Definition

Business Strategy, Structure, and CultureBusiness Strategy, Structure, and Culture

Needed Behavior and Outcomes/ResultsNeeded Behavior and Outcomes/Results

Compensation StrategyCompensation Strategy

Study Possible Competency SourcesStudy Possible Competency Sources

Select Competencies that FitSelect Competencies that Fit

Define & Execute Competencies to ProvideDefine & Execute Competencies to ProvideUnique Competitive AdvantageUnique Competitive Advantage



Advice for Use of Competency-Advice for Use of Competency-Based CompensationBased Compensation

1) Determine a need for change

2) Examine successful plans

3) Establish your own plan based on your organization, remembering your overall strategy and your organizational climate


Advice for Use of Competency-Advice for Use of Competency-Based CompensationBased Compensation

4) Determine how your plan will integrate with current hiring, training, and pay procedures

5) Involve in the planning everyone who will be affected by the results

6) Communicate every step of the way

7) Evaluate and reevaluate


The Changing Business The Changing Business EnvironmentEnvironment

Changing FromChanging From• Internal focus• Functional

hierarchies• Narrow job

specialization• Managerial authority• Independent

employees

Changing ToChanging To• External focus• Fewer levels of

Management

• Worker flexibility

• Employee Involvement• Interdependent workers


The Changing The Changing Business EnvironmentBusiness Environment

Changing ToChanging To• External focus• Fewer levels of

Management • Worker flexibility• Employee Involvement• Interdependent workers

New Rewards to New Rewards to Compensate NewCompensate New BehaviorsBehaviors

Impact on PayImpact on Pay• Customer satisfaction link• Blur nonmanagement/

management distinction • Lateral rewards• Entitlements eliminated• Peer/customer feedback• Reward by team leaders


Ready to Move to Teams?Ready to Move to Teams?

Is the team-based management approach the optimal management design for the organization based on its current situation?

Does the workflow lend itself to the benefits

that a team approach may yield for the organization?


Ready to Move to Teams?Ready to Move to Teams?

Is the current organizational culture so alien to the team concept that the organization must provide more fundamental training prior to implementation of the team concept?

Are current personnel able to adapt to the team concept or must human resource adjustments be made prior to the implementation?


Team ImplementationTeam Implementation

Decide what kind of teams (e.g., cross-functional, project) will be used, the number of teams employees can be part of, and how much empowerment will be given to the teams

Determine the mix of team rewards and individual rewards


Team ImplementationTeam Implementation

Define the performance measures and clearly tie the performance standards to strategic goals

Develop a method to collect the relevant information, store the data, and analyze the data for compensation decision making purposes

Establish a method to convert the results into rewards that the employees value and desire


Why Sales Incentive Plans Why Sales Incentive Plans

• Difficulty of supervising salespeople

• Image of salespeople as independent employees/entrepreneurs

• Advantage of tying pay to performance

• Means of dealing with multiple tasks & tying the incentive to the strategic plan

SalesSalesCompensationCompensation

PlansPlans

StraightSalary

Drawplus

Commission

Salaryplus

Commission

StraightCommission



Unique Problem of Sales Unique Problem of Sales Incentive PlansIncentive Plans

How does the organization set standards and take into account territorial differences?

New York City OnlyAll Montana

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