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Executives Compensation. Tereza Bůžková Veronika Holá Jakub Mikolášek. Introduction. Historic Development Optimal contracting x Managerial Power Types of Compensation Camouflage Optimal compensation packages. Historic Development. Executive pay relative to average wages in the US.
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Executives Compensation Tereza Bůžková Veronika Holá Jakub Mikolášek
Introduction • Historic Development • Optimal contracting x Managerial Power • Types of Compensation • Camouflage • Optimal compensation packages
Historic Development Executive pay relative to average wages in the US
Widening gap-reasons (1) • Share Options – to make managers think like owners – rising bull market increased share value
Widening gap-reasons(2) • Share options • Higher Fluctuation of CEOs – Tendency to search executives outside the company – underbidding
Widening gap-reasons (3) • Share options • Higher fluctuation of CEOs • Increase of average firm’s size – higher responsibility resulting in higher wages
Widening gap-reasons (4) • Share options • Higher fluctuation of CEOs • Increase of average firm’s size • Consultancy services – consultants create compensations packages – companies want to pay their managers at or above average
Theoretical Background • Separation of ownership and control • agency problem Owners Maximize shareholder value Managers –extract high rents –ensure stable income –gain prestige Need for incentives Compensation Packages
Managerial Power Compensation may be influenced by managers Reasons: • BOD election • Directors lack the independent information • Superior insider information • Interpersonal connections
Managerial Power (continued) When it is likely to be high? • Weak or inefficient BOD – BOD is too large – CEO = chairman of the board • No big outside shareholder →No enhanced monitoring or external power • Anti-takeover provisions →The manager’s position more secure
Market-based incentives • Threat of Takeover – in case of substantial underperformance
Market-based incentives FAILURE • Threat of Takeover – Generally very costly – in case of substantial underperformance • Entrenchment – staggered board – poison pills etc… – golden parachutes
Equity-based Incentives Links compensation to performance ≈ stock price • Target equity ownership level • Options
Equity-based Incentives FAILURE Links compensation to performance ≈ stock price – Stock price linked rather with market development • Target equity ownership level – Usually very low requirements – No punishment if breached • Options – No appropriate decrease in cash compensation – Option whirlpool
Careful Manager • Outrage costs –Embarrassment (negative media coverage etc.) –Shareholder disappointment → reduction of salary or firing out or takeover • Compensation Consultants • –underbidding
Preferred Compensation • Direct (cash) compensation → ? Outrage costs ? • Other benefits –(e.g. in UK about 30% of total compensation) • Options – convenient for both s-holders and COE
Preferred Compensation (continued) Camouflage (Stealth Compensation) • Retirement rents • Loans (since 2002 prohibited in US by SOA) – Often forgiven (at least in part) • Goodbye payments –Sometimes beneficial even for s-holders
„Optimal“ Compensation Options • Exercise price indexation • Limited cashing-out Equity • Target ownership plans Performance targets • Compensation linked to adj. Stock price, EPS,…
Sources: Literature: • Bebchuck, L. A., Fried, J. M., (2003):Executive compensation as an Agency problem, The journal of Economic Perspectives, Vol 17, No 3 • Barlett, L.R., Grant, J.H., Miller, T.I., (1999): Personality Differences and Executive Compensation, Eastern Economic Journal, Volume XVI, No. 3, July-September 1999 • Bolton, P., Scheinkman, J., Xiong, W.:Pay for Short Term Performance: Executive Compensation in Speculative Markets, NBER Working Paper Series, Working Paper 12107 • Kubo, K., (2002): The Determinants ot Executive Compensation in Japan and the UK: Agency Hypothesis or Joint Determination Hypothesis?, CEI Working Paper Series, No. 2001-2 • The Economist, January 20th 2007
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