A Human Resource Management Approach STRATEGIC COMPENSATION A Human Resource Management Approach Chapter 13 Compensating Executives Prentice Hall, Inc. © 2006 Prepared by David Oakes

Key Employees At any time during the current year the employee is either An officer making at least $145,000 A 5% owner, or A 1% owner making at least $150,000 Prentice Hall, Inc. © 2006

Highly Compensated Employee During the current or preceding year employee is either A 5 % owner An officer Prentice Hall, Inc. © 2006

Executive Compensation Current or annual core compensation Deferred core compensation: stock compensation Deferred core compensation: golden parachutes Enhanced protection program Benefits and perquisites Prentice Hall, Inc. © 2006

Bonus Types Discretionary Performance-contingent Predetermined allocation Target plan Prentice Hall, Inc. © 2006

Stock Plans Incentive stock options Nonstatutory stock options Restricted stock Phantom stock Discount stock options Stock appreciation Prentice Hall, Inc. © 2006

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 Prentice Hall, Inc. © 2006

Incentive Stock Stock purchased in the future for current price Capital gains are The difference between the purchase price and the stock option price Taxed at the time of disposition Prentice Hall, Inc. © 2006

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 Prentice Hall, Inc. © 2006

Restricted Stock Awarded at discounted price Ownership over stock in 5 – 10 years Must sale stock back at same price if they leave early Taxes paid at end of restriction period Prentice Hall, Inc. © 2006

Phantom Stock Executives awarded hypothetical stock Executives must be employee 5 – 20 years Executives must retire from company Capital gains paid at retirement Prentice Hall, Inc. © 2006

Discount Stock Option Plans Options granted at rates far below fair market value on the date its’ granted Executive receives benefit equal to difference between exercise price and fair market value Prentice Hall, Inc. © 2006

Stock Appreciation Rights Executive never has to exercise stock rights to receive income Income from difference between stock value when granted and the value at end of period Executive gets to keep the stock Income taxed when rights exercised Prentice Hall, Inc. © 2006

Golden Parachutes Provides executives pay & benefits following termination due to ownership change Income & benefits for 1 - 5 years Not triggered by retirement, resignation or disability Treated as a business expense Prentice Hall, Inc. © 2006

Enhanced Benefits Supplemental life insurance Supplemental retirement Perquisites Prentice Hall, Inc. © 2006

Common Perquisites Company car Financial services Legal services Recreational facilities Travel perks Residential security Tickets to sporting events Prentice Hall, Inc. © 2006

Key Players Compensation consultants Board of directors Compensation committees Prentice Hall, Inc. © 2006

Compensation Consultants Propose recommendations Develop packages based on strategic analysis External market context Internal factors Possible conflicts of interest Prentice Hall, Inc. © 2006

Board Of Directors Represent shareholders’ interests Usually 15 members CEOs & executives Community leaders Professionals Give final approval to recommendations Are compensated well for services Prentice Hall, Inc. © 2006

Compensation Committees Usually other board of directors’ members Major duties include: Review consultants’ recommendations Discuss assets & liabilities Make final recommendations Prentice Hall, Inc. © 2006

Executive Compensation Theories Agency theory Shareholders give control to executives Tournament theory Managers compete for promotions Social comparison theory Compensation compared to others Prentice Hall, Inc. © 2006

Disclosure Rules Governed by Securities and Exchange Commission (SEC) Securities Exchange Act of 1934 Amended in 1992 & 1993 Major objectives Clarify disclosure of compensation to CEO & top executives Increase board of directors’ accountability Prentice Hall, Inc. © 2006

SEC Disclosure Requirements Stock option & appreciation rights Long-term incentive plans Pension plan Stock performance comparison Compensation committee report Directors’ compensation Employment contracts & golden parachutes Prentice Hall, Inc. © 2006

Summary Compensation Table Compensation for CEO & 4 top-paid executives over 3-year period Disclosure of annual compensation Salary & bonuses Disclosure of long – term compensation All other compensation Prentice Hall, Inc. © 2006

Corporate Performance Measures Size Growth Profitability Capital markets Liquidity Leverage Prentice Hall, Inc. © 2006