Slide Number 1 out of 14 Executive Pay: The Plan n Video n The What + When + Why of Executive Pay n Components of Executive Pay n The Take Home Message

Slide Number 2 out of 14 The term Executive applies to: (IRS Guidelines) n 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 n Highly Paid Employees – Owns  5% of the firm – Earns  $75K/year – Earns  $50K/year & salary in top 20% of all employees

Slide Number 3 out of 14 “Do they deserve it?” n 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

Slide Number 4 out of 14 Is Executive Pay Important? And if so, why? n 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) n Why do executives get other incentive in addition to salaries?

Slide Number 5 out of 14 What are some of the components of Executive Pay? n Current or Annual Pay: – Salary (lame, old, bureaucratic, non-performance pay) – Bonuses (short-term performance base) n Deferred Pay: – Stocks (long-term performance pay) – Golden parachutes (“separation” pay) n Fringe Compensation – Benefits – Perquisites

Slide Number 6 out of 14 Current or Annual Pay Systems n 1. Salary: Base pay (…just for showing up…) n Why do CEO jobs not fall within formal pay structures? – Work is highly complex& unpredictable; responsibilities are broad, high visibility n 2. Bonuses: Pay-for-Performance (for achieving specific goals) n How many types of bonuses are there? Examples?

Slide Number 7 out of 14 Current or Annual Pay: Types of Bonuses n 1. Discretionary Bonus: – Awarded on elective basis, for making exceptionally smart/strategic moves n 2. Performance-contingent Bonus: – For attaining certain performance goals n 3. Predetermined Allocation Bonus: – Based on formula and company profits n 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

Slide Number 8 out of 14 Current or Annual Pay

Slide Number 9 out of 14 What are Deferred Pay Systems n Rendering payment at a future date n Main form of CEOs’ deferred pay: – Stocks = Long-term incentives n 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

Slide Number 10 out of 14 Deferred Pay Systems n What is another advantage of using deferred pay? – Provide tax advantages to CEOs n 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 39% 2) exercise & hold -> capital 20%

Slide Number 11 out of 14 Deferred Pay Systems n 1. Incentive Stock Options: – “options to buy” stocks (in the future) at discounted rates n 2. Non-statutory Stock Options: – CEOs pay tax on the  nce b/w the discounted price & market price n 3. Restricted Stocks: – CEOs get the stock, but not ownership (limited time frame) n 4. Phantom Stocks: Entrepreneurial firms, pre IPO

Slide Number 12 out of 14 Deferred Pay Systems n 5. Discount Stock Options: – Rates are far below market, pre-IPO, early stage n 6. Stock Appreciation Rights: – Income is available only at the end of the designated period n 7. Golden Parachute: – Pay & benefits after retirement

Slide Number 13 out of 14 Fringe Benefits n Enhanced Protection Benefits: – Life insurance, health benefits, favorable tax treatments, retirement plans (tailored for the CEO) n Perquisites = Perks: – Company car, jet, financial & legal planning/advice, – Events: meals, clothing, travel, tickets to events, n Is it really necessary?

Slide Number 14 out of 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