PowerPoint Chapter 11 - Strategic Compensation 9e

Strategic Compensation: A Human
Resource Management Approach

Ninth Edition
Chapter 11
Compensating
Executives
Copyright © 2017, 2015, 2013 Pearson Education, Inc. All Rights Reserved.
Learning Objectives (1 of 2)
11.1 Explain the difference between executive pay and pay
for nonexecutives.
11.2 Define executive status.
11.3 List the components of executive compensation
packages.
11.4 Discuss the principles and processes of setting
executive compensation.
Learning Objectives (2 of 2)
11.5 Summarize the executive compensation disclosure
rules and the reasons why they have been established.
11.6 Briefly explain the executive compensation controversy
as it relates to whether U.S. executives are paid too
much.
Learning Objective 11.1
• Explain the difference between executive pay and pay for
nonexecutives.
Contrasting Executive Pay with Pay for
Nonexecutive Employees (1 of 2)
• The chief executive officer (CEO) is the seller of his or her
services and the compensation committee is the buyer
• An awkward situation arises when the CEO hires a
compensation director or consultant
• The consultant recommends to the compensation
committee what the CEO compensation package should
be
Contrasting Executive Pay with Pay for
Nonexecutive Employees (2 of 2)
• A conflict of interest may arise because the consultant
may feel obligated to promote the financial interests of the
CEO, who hired the consultant
• Applying this practice contradicts the main assumption of
performance-based pay such as merit pay, which most
often applies to nonexecutive employees
• It is possible that CEOs could be compensated for
nonperformance
• Define executive status.
Key Employees (1 of 2)
Who Are Executives? (1 of 2)
• To understand the main difference, it is essential to define
what we mean by executives
• The Internal Revenue Service (IRS) recognizes two groups
of employees who play a major role in a company’s policy
decisions: key employees and highly compensated
employees
Who Are Executives? (2 of 2)
• Key employees are used by the IRS to determine the
necessity of top-heavy provisions in employer-sponsored
qualified retirement plans that cover most nonexecutive
employees
• Highly compensated employees are used by the IRS for
nondiscrimination rules in employer-sponsored health
insurance benefits
Key Employees (2 of 2)
• An officer having annual compensation greater than
$170,000 in 2015, Or
• An individual who for 2015 was either of the following:
– A 5% owner of the company
– A 1% owner having an annual compensation of more
than $150,000
Highly Compensated Employee
• A 5% owner at any time during the year, Or
• For the preceding year:
– Had compensation from the employer in excess of
$120,000 in 2015, And
– If the employer so chooses, the employee was in the
top-paid group of employees where top-paid
employees are the top 20 percent most highly
compensated employees
• List the components of executive compensation packages.
Broad Comparison of Executive and
Nonexecutive Compensation
• Executive compensation has both core and employee
benefits elements, much like compensation packages for
other employees
• Executive compensation packages emphasize long-term
or deferred rewards over short-term rewards
Executive Compensation
Components
• Current or annual core compensation
• Deferred core compensation: equity agreements
• Deferred core compensation: separation agreements
• Clawback provisions
• Employee benefits: enhanced protection program benefits
and perquisites
Components of Current Core
Compensation
Two components:
• Annual base pay
• Bonuses
LO 11-3 Annual Base Pay
• Fixed element of annual cash compensation
• Only up to $1 million in fixed annual salary is exempt from
a company’s tax liability
• CEO jobs do not fall within formal pay structures
– CEOs’ work is highly complex and unpredictable
– Setting CEO compensation differs from the rational
processes to build market-competitive structures
(reviewed later)
Bonus Types
• Discretionary: awarded on an objective basis
• Performance-contingent: based on the attainment of
specific performance criteria
• Predetermined allocation: based on a fixed formula
• Target plan: ties bonuses to executives’ performance
Deferred Compensation: Equity
Agreements
• Equity refers to ownership stake in a company, particularly
focused on financial interests
• Company stock represents equity shares of equal value
• A variety of important terminology to fully understand these
concepts (next slide)
Stock Terminology
• 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
Stock Plans
• Stock options
– Incentive stock options
– Nonstatutory stock options
• Restricted stock plans and restricted stock units
• Stock appreciation rights
• Phantom stock
• Employee stock purchase plans
Incentive Stock Options
• An executive’s right to a future purchase of their
company’s stock at a predetermined price, often at the
stock price when the options were granted
• Capital gains and capital losses:
– Capital gains: the difference between the higher
purchase price and the lower stock option price (taxed
at the time of disposition)
– Capital loss: the difference between the lower
purchase price and the higher stock option price
Nonstatutory Stock Options
• Company awards stock at discounted price
• No favorable tax treatment
• Taxes paid on difference between the discounted price and
the fair market value at the time stock was granted
Restricted Stock
• Executive is awarded its company stock options or stock
units at the market or a discounted price
• Ownership of stock is granted at a specified future date,
often multiple years (vesting period)
• Executive must sell stock back to the company at the
same price if they leave before vested
Stock Appreciation Rights
• Similar to restricted stock options, but the executive never
has to exercise stock rights to receive income
• Instead, the company awards a bonus payment:
– The difference in stock price between the time the
company granted the stock rights at fair market value
to the end of the designated period
• This arrangement permits the executive to keep the stock
Phantom Stock
• Bonus in the form of the equivalent of either the value of
company shares or the increase in value over a period of
time based on meeting two conditions:
– Executives must be employed for many years
– Executives must retire from the company
Employee Stock Purchase Plans
• Executive may purchase stock after a specified time period
• The executive sets aside money through payroll deduction
throughout this time, which is the offering period
• Companies may establish stock purchase plans on a tax
qualified or nonqualified basis
Deferred Compensation: Separation
Agreements
• Golden parachutes
• Platinum parachutes
Golden Parachutes
• Provide executives pay and benefit following termination
due to ownership change or corporate takeover (merger or
combining of two separate companies)
• Advantages to executives and the company:
– Limit an executive’s risk on occasion of these
unforeseen events
– Promote recruitment of talented executives
– Virtually eliminate an executive from making decisions
to save his/her job at the expense of company welfare
Platinum Parachutes
• Lucrative awards that compensate departing executives
with:
– Severance pay
– Continuation of company benefits
– Stock options
• Awarded in order to avoid legal battles or critical press
reports
Clawback Provisions
• Allow board of directors to take back performance-based
compensation when performance goals were not achieved
• These provisions becoming more common because of
increasing public scrutiny of executive compensation
practices
Employee Benefits
• Employee benefits represents an additional key
component of executive compensation packages:
– Enhanced benefits
– Common perquisites
Enhanced Benefits
• Supplemental life insurance: increases the value of
executives’ estates bequeathed to designated beneficiaries
(usually family members) upon their deaths, as well as
provides executive with preferred tax treatments
• Supplemental retirement: restores benefits restricted
under qualified plans
• Perquisites: cover a broad range of benefits, from free
lunches to the free use of corporate jets
Common Perquisites (1 of 2)
• Company car
• Security services
• Legal services
• Recreational facilities
• Travel perks
Common Perquisites (2 of 2)
• Among Fortune 500 companies, about 85% offer perks to
their CEOs
• Typically, these companies offer fewer perks than before
• The percentage of companies offering three or more perks
has dropped from 60% to 30% since 2008
• The percentage of companies dropping perks altogether
increased to 15% from 6% in 2008
• Discuss the principles and processes of setting executive
compensation.
Key Players
• Compensation consultants
• Board of directors
• Compensation committees
Compensation Consultants
• Propose recommendations
• 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 and executives
– Community leaders
– Professionals
• Give final approval to recommendations
• Are compensated well for services, often, more than
$50,000 annually
Compensation Committees
• Usually other board of directors’ members
• Major duties include:
– Review consultants’ recommendations
– Discuss assets and liabilities
– Make final recommendations
Executive Compensation Theories
• Agency theory
– Shareholders give control to executives
• Tournament theory
– Managers compete for promotions
• Social comparison theory
– Compensation compared to others
CEO Compensation as a Tournament
• Summarize the executive compensation disclosure rules
and the reasons why they have been established.
Disclosure Rules
• Securities Exchange Act of 1934
– Amended in 1992 and 1993
– Clarify disclosure of compensation to CEO and top
executives
– Increase board of directors’ accountability
• Wall Street Reform and Consumer Protection Act of 2010
(Dodd-Frank Act)
SEC Disclosure Requirements:
Definitive Proxy Statement (DEF 14A)
• Compensation information for the CEO and Named
Executive Officers (NEOs)
• NEOs are the four most highly compensated officers after
the CEO
• Disclosure must be presented in tabular and narrative form
• The narrative is referred to as the Compensation
Discussion and Analysis (CD&A)
Executive Compensation to Be
Disclosed
• Stock option and appreciation rights
• Long-term incentive plans
• Pension plan
• Stock performance comparison
• Compensation committee report
• Directors’ compensation
• Employment contracts and golden parachutes
Summary Compensation Table (1 of 7)
• Compensation for CEO and four top-paid executives over
three-year period
• Disclosure of annual compensation
• Disclosure of long-term compensation
• “All other compensation ($)”
Table 11-4 2008 Summary Compensation Table
Blan Annual Long-term All Other
Blank k Compensation Compensation Compensation ($)
Keith S. Sherin, Vice
2008 $1,500,000 $2,550,000 $2,987,493
Chairman and CFO
Blank 2007 $1,354,167 $3,000,000 $3,076,095
Blank 2006 $1,225,000 $2,550,000 $2,808,919
Michael A. Neal, Vice
2008 $1,650,000 $2,900,000 $3,512,898
Chairman
Blank 2007 $1,550,000 $3,880,000 $4,212,201
Blank 2006 $1,400,000 $3,300,000 $3,906,929
John G. Rice, Vice
2008 $1,650,000 $2,700,000 $3,659,090
Chairman
Blank 2007 $1,550,000 $3,000,000 $4,406,900
Blank 2006 $1,400,000 $2,550,000 $4,122,437
[Table 11-4 continued]
Blan Annual Long-term All Other
Blank k Compensation Compensation Compensation ($)
Brackett B. Denniston,
Senior Vice President,
2008 $1,200,000 $1,850,000 $2,284,110
General Counsel and
Secretary
David R. Nissen,
Former President & 2008 $1,350,000 $1,310,000 $6,777,594
CEO, GE Money
Robert C. Wright,
2008 $916,667 $2,783,000 Blank
Former Vice Chairman
blank 2007 $2,750,000 $7,590,000 $1,943,665
blank 2006 $2,500,000 $6,900,000 $2,516,712
Source: Based on Summary Compensation Table: 17 C.F.R 229.402(b), as amended November 29, 1993, effective
January 1, 1994.
2008 All Other Compensation Table
We provide our named executives with additional benefits, reflected in the table below for 2008, that we
believe are reasonable, competitive, and consistent with the company’s overall executive compensation
program. The costs of these benefits constitute only a small percentage of each named executive’s total
compensation.
Other Tax Value of Supplemental Payments Relating

Name of
Benefitsa Paymentb Life Insurance to Employee Total ($)
Executive
($) ($) Premiumsc ($) Savings Pland ($)
Immelt 212,293 0 152,476 8,050 372,819
Sherin 178,522 14,403 87,743 8,050 288,718
Neal 185,253 0 150,741 8,050 344,044
Rice 130,547 12,915 109,561 8,050 261,073
Denniston 74,943 21,000 146,864 8,050 250,857
Nissen 34,695 4,923 142,758 8,050 190,426
Wright 1,274,024 13,195 784,789 8,050 2,080,058
a
See the 2008 Other Benefits Table for additional information. b This column
reports amounts reimbursed for the payment of taxes with respect to financial
counseling, tax preparation services, and the personal use of car service.
Starting in 2009, the company will no longer reimburse named executives for
the payment of these taxes. See the 2008 Other Benefits Table for the
incremental costs associated with providing these services. c This column
reports taxable payments made to the named executives to cover premiums for
universal life insurance policies owned by the executives. These policies
include: (1) Executive Life, which provides universal life insurance policies for
the named executives totaling $3 million in coverage at the time of enrollment,
increased 4 percent annually thereafter, and (2) Leadership Life, which provides
universal life insurance policies for the named executives with coverage of two
times their salary plus 100 percent of their latest bonus payments. The amount
for Mr. Wright also includes Supplemental Life, the predecessor plan to
Executive Life. d This column reports company matching contributions to the
named executives’ 401(k) savings accounts of 3.5 percent of pay up to the
limitations imposed under IRS rules.
2008 Other Benefits
The following table describes other benefits and the incremental cost to the company of
providing them in 2008. The total amount of these other benefits is included in the 2008 All
Other Compensation Table above for each named executive.
Use of Leased
Name of Financial Counseling and Otherd Total
Aircrafta Carsb
Executive Tax Preparationc ($) ($) ($)
($) ($)
Immelt 189,449 0 0 22,844 212,293
Sherin 116,673 31,170 20,575 10,104 178,522
Neal 175,060 0 0 10,193 185,253
Rice 69,484 18,534 18,450 24,079 130,547
Denniston 9,713 28,620 30,000 6,610 74,943
Nissen 0 21,040 7,033 6,622 34,695
Wright 244,083 8,832 12,790 1,008,319 1,274,024
a
The calculation of incremental cost for personal use of company aircraft includes the
variable costs incurred as a result of personal flight activity: a portion of ongoing
maintenance and repairs, aircraft fuel, satellite communications, and any travel expenses
for the flight crew. It excludes nonvariable costs, such as exterior paint, interior
refurbishment, and regularly scheduled inspections, which would have been incurred
regardless of whether there was any personal use of the aircraft. b Includes expenses
associated with the leased cars program, such as leasing and management fees,
administrative costs, and gas allowance. c Includes expenses associated with the use of
advisors for financial, estate, and tax preparation and planning, as well as investment
analysis and advice. d This column reports the total amount of other benefits provided, none
of which individually exceeded the greater of $25,000 or 10 percent of the total amount of
these benefits for the named executive. These other benefits included: (1) car service fees,
(2) home alarm and generator installation, maintenance, and monitoring, (3) costs relating
to company-sponsored events at board meetings for the executives’ spouses, (4)
participation in the Executive Products and Lighting Program pursuant to which executives
can receive GE appliances or other products with incremental cost calculated based on the
fair market value of the products received, and (5) an annual physical examination. For Mr.
Wright, the amount includes contributions aggregating $1 million made by the company to
charitable organizations upon Mr. Wright’s retirement as a director.
Dodd-Frank Act
• Four major provisions:
– Say on Pay vote
– Independence requirements for compensation
committee members and advisors
– Disclosure of circumstances under which an executive
would benefit from a golden parachute arrangement
– Disclosure of the ratio of CEO pay to the median
compensation of nonexecutive employees
• Briefly explain the executive compensation controversy as
it relates to whether U.S. executives are paid too much.
Are U.S. Executives Paid Too Much?
• Comparison between executive compensation and other
work groups
• Strategic questions: Is pay for performance
• Ethical considerations: Is executive compensation fair
• International competitiveness
Comparison Between Executive
Compensation and Other Work Groups
• Median annual earnings for all civilian U.S. workers was
$47,230 in 2014
• Least paid nonexecutive—fast food cooks at $19,480
• Highest paid nonexecutive—anesthesiologists at $246,320
• Typical annual salary and bonus for chief executives was
about $3.5 million
Median Annual Nonexecutive
Earnings, May 2014
Table 11-6 Selected Median Annual Nonexecutive Earnings, May 2014
Occupation Annual Earnings ($)

Anesthesiologists 246,320
Lawyers 133,470
General and operations managers 117,200
Registered nurses 69,700
Construction and equipment operators 47,340
Office clerks 30,820
Teacher assistants 26,000
Fast-food cooks 19,480
Source: U.S. Bureau of Labor Statistics. (2015). Occupational Employment Wages—May 2014 (USDL: 15-0479).
Available: https://www.bls.gov/, accessed April 7, 2015.
Strategic Questions: Is Pay for
Performance?
• Difficult to say ‘yes’ or ‘no’
• Evidence is mixed based on decades of academic
research
• There are complex forces beyond the control of CEOs
(ex. economic downturns, government regulation)
Corporate Performance Measures (1 of 3)
Size
• Sales
• Assets
• Profits
• Market value
• Number of employees
Growth
• Sales
• Assets
• Profits
• Market value
• Number of employees
Profitability
• Profit margin
• Return on assets (ROA)
• Return on equity (ROE)
Capital Markets
• Dividend yield
• Total return to shareholders
• Price–earnings ratio
• Payout
Liquidity
• Current ratio
• Quick ratio
• Working capital from operations
• Cash flow from operations
Leverage
• Debt-to-equity ratio
• Short-term vs. long-term debt
• Cash flow vs. interest payments
Ethical Considerations: Is Executive
Compensation Fair? (1 of 3)
• Company’s ability to attract and retain top executives
– Compensation packages for external candidates were
42% higher than for CEOs who were promoted from
within
– About 50% of total compensation was awarded in
equity agreements
• Income disparity between executives and nonexecutive
employees
– The AFL-CIO maintains that the CEO-to-minim wage
pay ratio was 774:1
– CEO annual compensation was nearly 180 times
greater than the typical fast food cook’s annual pay
• Layoffs of thousands of nonexecutive employees for a
variety of reasons
– Global competition
– Reduction in demand
– Technological advances
– Mergers and acquisitions
– Relocating production plants overseas
– Economic recessions
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Strategic Compensation: A Human

Resource Management Approach

Other Tax Value of Supplemental Payments Relating

Occupation Annual Earnings ($)

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