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Executive Pay: The Plan

Executive Pay: The Plan. Video The What + When + Why of Executive Pay Components of Executive Pay The Take Home Message. The term Executive applies to : (IRS Guidelines). Key Employees One of 10 employees owning the largest % of the firm Owns  5% of the firm

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Executive Pay: The Plan

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  1. Executive Pay: The Plan • Video • The What + When + Why of Executive Pay • Components of Executive Pay • The Take Home Message

  2. The term Executive applies to:(IRS Guidelines) • Key Employees • One of 10 employees owning the largest % of the firm • Owns  5% of the firm • Earns more than $150K/year + owns  1% of firm • Officers whose pay  $45K/year are excluded • Highly Paid Employees • Owns  5% of the firm • Earns  $75K/year • Earns  $50K/year & salary in top 20% of all employees

  3. “Do they deserve it?” • Social/Ethical: “do they deserve it?” • Annual pay packages reach 8, 9, 10 digit figures • McCaw (Cellular Comm., 1989): $54 million, while his company was losing money… • 1990: CEOs’ pay increased 17.4% = 3 times inflation rate or 3 times middle managers’ pay • 1995: CEOs/Non-execs = 7/1 • $ of CEOs / $ employees: 200/1 (US) vs. 17/1 (Japan) • Example: $50K  $10 million

  4. Is Executive Pay Important? And if so, why? • Strategic Issues • CEOs set standards/examples for subordinates to follow (e.g., “domino effect” that starts with the CEO and ultimately impacts the entire workforce) • Pay systems impact CEOs’ thinking, behaviors, & decision-making • CEOs lead the whole organization • Pay = Communication tool (i.e., the what & how of pay systems send a strong msg. to entire organization) • Why do executives get other incentive in additionto salaries?

  5. What are some of the components of Executive Pay? • Current or Annual Pay: • Salary (lame, old, bureaucratic, non-performance pay) • Bonuses (short-term performance base) • Deferred Pay: • Stocks (long-term performance pay) • Golden parachutes (“separation” pay) • Fringe Compensation • Benefits • Perquisites

  6. Current or Annual Pay Systems • 1. Salary: Base pay (…just for showing up…) • Why do CEO jobs not fall within formal pay structures? • Work is highly complex& unpredictable; responsibilities are broad, high visibility • 2. Bonuses: Pay-for-Performance (for achieving specific goals) • How many types of bonuses are there? Examples?

  7. Current or Annual Pay: Types of Bonuses • 1. Discretionary Bonus: • Awarded on elective basis, for making exceptionally smart/strategic moves • 2. Performance-contingent Bonus: • For attaining certain performance goals • 3. Predetermined Allocation Bonus: • Based on formula and company profits • 4. Target Plan Bonus: • Ties bonus to firm performance  = there are many types of bonuses and all of them are (or should be) performance-related

  8. Current or Annual Pay

  9. What are Deferred Pay Systems • Rendering payment at a future date • Main form of CEOs’ deferred pay: • Stocks = Long-term incentives • What does deferred pay supposed to do? • Create a sense of ownership, aligning the interest of the CEO with those of the firm (shareholders) • Why? • B/c most CEOs are agents, not owners

  10. Deferred Pay Systems • What is another advantage of using deferred pay? • Provide tax advantages to CEOs • How? • CEOs do not pay tax on payment until they receive it. Presumably, their income tax rates will be substantially lower during retirement, when their total income is at lower bracket • Options: 1) exercise & sell -> income tax @ 39% 2) exercise & hold -> capital gain @ 20%

  11. Deferred Pay Systems • 1. Incentive Stock Options: • “options to buy” stocks (in the future) at discounted rates • 2. Non-statutory Stock Options: • CEOs pay tax on the nce b/w the discounted price & market price • 3. Restricted Stocks: • CEOs get the stock, but not ownership (limited time frame) • 4. Phantom Stocks: Entrepreneurial firms, pre IPO

  12. Deferred Pay Systems • 5. Discount Stock Options: • Rates are far below market, pre-IPO, early stage • 6. Stock Appreciation Rights: • Income is available only at the end of the designated period • 7. Golden Parachute: • Pay & benefits after retirement

  13. Fringe Benefits • Enhanced Protection Benefits: • Life insurance, health benefits, favorable tax treatments, retirement plans (tailored for the CEO) • Perquisites = Perks: • Company car, jet, financial & legal planning/advice, • Events: meals, clothing, travel, tickets to events, • Is it really necessary?

  14. The Take Home? 1 = Know that there are many types of deferred pay systems 2 = Try to understand why & when companies use stocks as incentives 3 = Know the advantages & disadvantages of stock options and other deferred payments 4 = Know some of the perks executives get (& employees don’t) 5 = Size, not performance, is the strongest (not best) predictor of CEOs’ pay

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