Compensation Chapter 12

Agency Theory (KEY THEORY)

-shareholders delegate control to top executives
-top execs don't own majority shares of their company stocks--> this may lead to them not sharing the same interests as the collective shareholders

*compensation, specificallycurrent & deferred compensation, used to align executives interests with shareholders’ interests

*based around the idea of competition

Lucrative exec. comp is the prize in a series of contests (tournament) among middle & top level managers who want to be CEOs

--promotion to a higher rank signifies a win & prize = more lucrative compensation
--As you rise higher in the company there are less positions available (more difficult competition) and prizes become higher also

Individuals evaluate their accomplishments by comparing themselves to similar individuals

--Use of compensation committee members’ own compensation packages or packages of other CEOs to determine executive compensation package

The IRS recognizes 2 groups of employees who play a major role in company's policy decisions

Key Employees--> term used by IRS to determine necessity of top heavy provisions (too many benefits given to key employees; 60% benefits held by key = plan not qualified) in employer-sponsored qualified retirement plans that cover most non-executive employees; if a company becomes top-heavy they must balance it out by providing more benefits (generally around 3%) to all other eee’s

Key Employee is an employee who at any time during the year is
*a 5% owner in the company
*a 1% owner having an annual compensation of more than $150,000
*An officer having an annual compensation greater than $170,000



Highly Compensated Employees--> term used by IRS for nondiscrimination rules in employer-sponsored health insurance benefits

Highly compensated employee as one of the following during the current or preceding year:
*1 of 5 of the highest paid officers
*a shareholder owning more than 10%
*an employee among the 25% highest paid in the company

Annual Base Pay

Bonuses

Deferred Core Compensation

Annual Base Pay:

--fixed element of annual cash compensation
--not usually where the higher amounts of money come in
--CEO jobs do not fall withing formal pay structures because
*the work is highly complex & unpredictable
*setting this comp differes in order to build market competitive structures

Bonuses (Short or Long Term)

*Short Term Incentive Compensation for executives are designes to reward them for meeting intermediate perforamnce criteria (related to performance of company as defined by competitive strategy)

Types of Bonuses:

--Discretionary:awarded on an objective/elective basis (more short term)

--Performance Contingent: based on the attainment of specific performance criteria (more aligned w/ typical performance based bonuses)

--Pre-determined Allocation: based on a fixed formula; central factor in the formula is company profits

--Target Plan: ties bonuses to executives’ performance; amount increases commensurately with performance (not fixed formula like pre-determined allocation)

An agreement between employee & company to render payments to employee at a future date; used with exec comp to create sense of ownership, to align interests of exec with interests of owners/shareholders over long term

*provides tax advantages;execs don’t have to pay taxes on deferred comp until they receive it (when they will probably have a lower tax rate at retirement)

6 Stock Plans:
Incentive Stock Options
Non Statutory Stock Options
Discount Stick Options
Restricted Stock
Phantom Stock
Stock Appreciation Rights (SARS)

Stock Options: right granted to employee to purchase stock @ a designated price within a specified period of time

Stock Grants:company offering of stock to employee

Exercise of Stock Grants:employee purchase of stock, using stock options

Disposition:sale of stock by employee

Fair Market Value: average stock price on the NYSE

Entitles executives to purchase stock in the future, for the current (today's) price
**essentially allowing for purchase at a discounted rate

--Capital Gains: the difference between the purchase price and the stock option price; this gain is not taxed until disposition of stock

Stock options awarded at discounted prices BUT they do not qualify for the tax break

--taxes paid on the difference at the time of the stock grant

Similar to Non-statutory stock options

--Except the discounted rate is exceptionally good!

Stock awarded at a discounted price

--Executive DO NOT have ownership control over the stock for a predetermined period (5-10 years) or until a specific performance goal is reached
(you don't own it until you vest or hit goal)

--if the executive leaves early, the stock must be sold back to the company for the same price they purchased it or it become forfeit

--Taxes are not paid on this type of stock until the end of the restriction period

A promise to pay a bonus stock

--share in success with no actual equity in the company

--Cash or stock bonus based on value of a stated # of shares or from increase in value over period of time

--Execs must meet specific conditions before allowed to convert phantom into real shares:
**remain emplyed for specified period
**retire from that company

Provide executives income at the end of a designated period without having to actually exercise the rights to receive income

--payment simply awarded to executives based on difference in stock price from granting of stock rights to end of designated period

--Tax on income from gains paid when they exercise other stock rights or when converted