A Human Resource Management Approach

STRATEGIC COMPENSATION

Prepared by David OakesChapter 13Compensating Executives

Defining executive statusWho are executivesKey EmployeesAt any time during the current year the employee is either An officer making at least $145,000A 5% owner, orA 1% owner making at least $150,000 Highly Compensated EmployeeDuring the current or preceding year employee is either A 5 % ownerFor the preceding year had compensation from the employer in excess of $80,000

Executive Compensation Current or annual core compensation Deferred core compensation: stock compensation Deferred core compensation: golden parachutes Fringe compensation: Enhanced protection program and Benefits and perquisites

Components Current or annual core compensationBase payPay ranges and pay grades higher for .BonusesDiscretionary: 4 factors: company profits, the financial condition of the company, business conditions, and prospects for the future.Performance-contingent: specific performance criteriaPredetermined allocation: fixed formulaTarget plan: ties bonuses to executives performance.

Components of Deferred core compensation: Stock Plans Incentive stock options Nonstatutory stock options Restricted stock Phantom stock Discount stock options Stock appreciation

Stock TerminologyCompany stock: total equity of the firmCompany stock shares: equity segments of equal value. Stock options - stocks purchased at a designated price for a specific time Stock grants - a company offers stock to employees Exercise of stock grants - purchase of stock Disposition - sale of stock Fair market value - average stock price on the NYSE

Incentive Stock Stock purchased in the future for current price Capital gains are The difference between the purchase price and the stock option price Taxed at the time of disposition

Non-statutory Stock Options Company awards stock at discounted price Do not qualify for favorable tax treatment Taxes paid on difference between the discounted price and the fair market value at the time stock was grantedDo not provide executives an advantage

Restricted StockAwarded at discounted price Ownership over stock in 5 10 yearsMust sale stock back at same price if they leave earlyTaxes paid at end of restriction periodThis is a common type of long-term executive compensation

Phantom Stock Executives awarded by hypothetical company stock rather than actual shares of company stocks.2 conditions: Executives must be employee 5 20 yearsExecutives must retire from company Capital gains paid at retirement

Discount Stock Option PlansSimilar to non-statutory but with one exception:

Options granted at rates far below fair market value on the date its been granted

Executive receives benefit equal to difference between exercise price and fair market value

Stock Appreciation Rights Executive never has to exercise stock rights to receive income Income from difference between stock price when granted and the value at end of period Executive gets to keep the stock Income taxed when rights exercised

Golden ParachutesProvides executives pay & benefits after a termination resulting from a change in ownership or corporate take over.Extend pay and benefits from 1 - 5 years, depending upon the agreement.Not triggered by planned retirement, resignation or disability Treated as a business expense

Fringe compensation: Enhanced protection programs Benefits and perquisites Enhanced protection programs Benefits:Supplemental life insurance Supplemental retirementPerquisitesLegally required benefits apply to executives, with the exception of one provision FMLA of 1993.

Common Perquisites Company car Financial services Legal services Recreational facilities Travel perks Residential security Tickets to sporting events

Principles and process for setting executive compensationKey Players: Executive Compensation consultantsBoard of directorsCompensation committees

Executive Compensation ConsultantsPropose recommendations for alternative pay packages Develop packages based on strategic analysis External market context Internal factors Possible conflicts of interest

Board Of Directors Represent shareholders interests Usually 15 members CEOs & executives Community leaders Professionals Give final approval to recommendations Are compensated well for services

Compensation Committees Usually other board of directors members Major duties include: Review consultants recommendations Discuss assets & liabilities Make final recommendations

Executive Compensation Theories Agency theory Shareholders give control to top executives to represent their ownership interests.Agency problem: actions of executives on behalf of their own self-interest Tournament theory Managers compete for promotions Social comparison theory Compensation compared to others demographic and occupation common features.

Disclosure Rules Governed by Securities and Exchange Commission (SEC) Securities Exchange Act of 1934 Amended in 1992 & 1993 Major objectives Clarify disclosure of compensation to CEO & the four most highly paid top executives Increase board of directors accountability for executives compensation policies and decisions.

SEC Disclosure Requirements Stock option & appreciation rights Long-term incentive plans Pension plan Stock performance comparison Compensation committee report Directors compensation Employment contracts & golden parachutes

Summary Compensation Table Compensation for CEO & 4 top-paid executives over 3-year period Disclosure of annual compensation Salary & bonuses Disclosure of long term compensation All other compensation

Corporate Performance Measures Size Growth Profitability Capital markets Liquidity Leverage