Executives Compensation Tereza Bůžková Tereza Bůžková Veronika Holá Veronika Holá Jakub...
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Transcript of Executives Compensation Tereza Bůžková Tereza Bůžková Veronika Holá Veronika Holá Jakub...
ExecutivesExecutives CompensationCompensation
• Tereza BůžkováTereza Bůžková• Veronika HoláVeronika Holá
• Jakub MikolášekJakub Mikolášek
IntroductionIntroduction
• Historic DevelopmentHistoric Development
• Optimal contracting x Managerial Optimal contracting x Managerial PowerPower
• Types of CompensationTypes of Compensation
• CamouflageCamouflage
• Optimal compensation packagesOptimal compensation packages
Historic DevelopmentHistoric DevelopmentExecutive pay relative to average wages in Executive pay relative to average wages in
the USthe US
The Economist 01/2007
0
50
100
150
200
250
300
350
median
mean
Widening gap-reasons Widening gap-reasons (1)(1)
• Share OptionsShare Options
–– to make managers think like to make managers think like owners owners
–– rising bull market increased share rising bull market increased share valuevalue
Widening gap-reasonsWidening gap-reasons (2)(2)
• Share optionsShare options
• Higher Fluctuation of CEOsHigher Fluctuation of CEOs
–– Tendency to search executives Tendency to search executives outside theoutside the
companycompany
–– underbiddingunderbidding
Widening gap-reasons Widening gap-reasons (3)(3)
• Share optionsShare options
• Higher fluctuation of CEOsHigher fluctuation of CEOs
• Increase of average firm’s sizeIncrease of average firm’s size
–– higher responsibility resulting in higher responsibility resulting in higher wageshigher wages
Widening gap-reasons Widening gap-reasons (4)(4)
• Share optionsShare options
• Higher fluctuation of CEOsHigher fluctuation of CEOs
• Increase of average firm’s sizeIncrease of average firm’s size
• Consultancy servicesConsultancy services–– consultants create compensations packagesconsultants create compensations packages
–– companies want to pay their managers at companies want to pay their managers at oror
above averageabove average
Theoretical BackgroundTheoretical Background
• Separation of ownership and controlSeparation of ownership and control→ agency problemagency problem
Owners
Maximize shareholder value
Managers
–– extract high rents
–– ensure stable income
–– gain prestige Need for incentives Compensation Packages
Managerial PowerManagerial Power
Compensation may be influenced by Compensation may be influenced by managersmanagers
Reasons:Reasons:•BOD electionBOD election•Directors lack the independent Directors lack the independent
informationinformation•Superior insider informationSuperior insider information•Interpersonal connectionsInterpersonal connections
Managerial Power Managerial Power (continued)(continued)
When it is likely to be high?When it is likely to be high?
• Weak or inefficient BODWeak or inefficient BOD–– BOD is too largeBOD is too large
–– CEO = chairman of the boardCEO = chairman of the board
• No big outside shareholderNo big outside shareholder → → No enhanced monitoring or No enhanced monitoring or
external powerexternal power
• AntiAnti--takeover provisionstakeover provisions→→ The manager’s position more secureThe manager’s position more secure
Market-based incentivesMarket-based incentives
• Threat of Takeover Threat of Takeover
– – in case of substantialin case of substantial
underperformanceunderperformance
Market-based incentivesMarket-based incentives
• Threat of TakeoverThreat of Takeover –– Generally very Generally very costlycostly
– – in case of substantialin case of substantial
underperformanceunderperformance
• EntrenchmentEntrenchment– – staggered boardstaggered board
– – poison pills etc…poison pills etc…
– – golden parachutesgolden parachutes
FAILURE
Equity-based IncentivesEquity-based Incentives
Links compensation to performance ≈ Links compensation to performance ≈ stock pricestock price
• Target equity ownership levelTarget equity ownership level
• OptionsOptions
Equity-based IncentivesEquity-based IncentivesFAILURE
Links compensation to performance ≈ stock priceLinks compensation to performance ≈ stock price
–– Stock price linked rather with market developmentStock price linked rather with market development• Target equity ownership levelTarget equity ownership level
–– Usually very low requirementsUsually very low requirements
–– No punishment if breachedNo punishment if breached
• OptionsOptions
–– No appropriate decrease in cash compensationNo appropriate decrease in cash compensation
–– Option whirOption whirllpoolpool
Careful ManagerCareful Manager• Outrage costs
–– EmbarrassmentEmbarrassment (negative media coverage etc.) (negative media coverage etc.)
–– Shareholder disappointmentShareholder disappointment→ → reduction of salary or firing out or reduction of salary or firing out or
takeovertakeover
• Compensation Consultants
–– underbidding
Preferred CompensationPreferred Compensation• Direct (cash) compensationDirect (cash) compensation
→ → ? ? Outrage costs Outrage costs ??
• Other benefitsOther benefits
–– (e.g. in UK about 30% of total (e.g. in UK about 30% of total compensation)compensation)
• OptionsOptions
–– convenient for both s-holders and COEconvenient for both s-holders and COE
PreferPreferrred Compensation ed Compensation (continued)(continued)
Camouflage (Stealth Compensation)Camouflage (Stealth Compensation)• Retirement rentsRetirement rents
• Loans (Loans (since 2002 prohibited in US by since 2002 prohibited in US by SOASOA))– – Often forgiven (at least in part)Often forgiven (at least in part)
• Goodbye paymentsGoodbye payments–– Sometimes beneficial even for s-Sometimes beneficial even for s-
holdersholders
„„OptimalOptimal“ Compensation“ CompensationOptionsOptions• Exercise price indexationExercise price indexation• Limited cashing-outLimited cashing-out
EquityEquity• Target ownership plansTarget ownership plans
Performance targetsPerformance targets• Compensation linked to adj. Stock price, Compensation linked to adj. Stock price,
EPS,…EPS,…
Sources:Sources:Literature:Literature:• Bebchuck, L. A., Fried, J. M., (Bebchuck, L. A., Fried, J. M., (2003):2003): Executive Executive
compensation as an Agency problem, The journal of compensation as an Agency problem, The journal of Economic Perspectives, Vol 17, No 3Economic Perspectives, Vol 17, No 3
• Barlett, L.R., Grant, J.H., Miller, T.I., Barlett, L.R., Grant, J.H., Miller, T.I., (1999): (1999): Personality Differences and Executive Compensation, Personality Differences and Executive Compensation, Eastern Economic Journal, Volume XVI, No. 3, July-Eastern Economic Journal, Volume XVI, No. 3, July-September 1999September 1999
• Bolton, P., Scheinkman, J., Xiong, W.Bolton, P., Scheinkman, J., Xiong, W.:: Pay for Short Pay for Short Term Performance: Executive Compensation in Term Performance: Executive Compensation in Speculative Markets, NBER Working Paper Series, Speculative Markets, NBER Working Paper Series, Working Paper 12107 Working Paper 12107
• Kubo, K., Kubo, K., (2002): The Determinants ot Executive (2002): The Determinants ot Executive Compensation in Japan and the UK: Agency Hypothesis or Compensation in Japan and the UK: Agency Hypothesis or Joint Determination Hypothesis?, CEI Working Paper Joint Determination Hypothesis?, CEI Working Paper Series, No. 2001-2Series, No. 2001-2
• The EconomistThe Economist, January 20th 2007, January 20th 2007
Still awake?Still awake?
Thank you for Thank you for attention attention