1. Week 10 Abusive Compensation Practices Faisal AlSager MGT 427 - Corporate Governance

2. Objectives ✤ To have a background about some issues related to the wrongful executive compensation practices

3. Stock Options - How It Works ✤ The company gives the option recipient the right to purchase a block of the company’s stock at some specified point of time in the future at a “strike price” set at the time of award, often current trading price ✤ If the stock rises between the time of the award and the time the option is exercised, the executive will get the benefit of the gain, without having had to make the capital expenditure to buy the stock

4. Are Stock Options Good Compensation Strategy? ✤ Stock options are supposed to be the ultimate example of compensation for performance ✤ The person granted the options will make money unless the stock goes up ✤ Someone says, “the company’s stock option program is designed to focus attention on stock values, and to develop Company ownership, promote employee loyalty, reward long-term business success and develop a parallel interest between key employees and shareholders” ✤ Buffet disagrees! ✤ Philip Morris gave CEO Hamish Maxwell options on 500,000 shares on retirement!

5. ✤ The most troubling aspect of stock option awards is “re-pricing” ✤ Re-pricing is reissuing stock options when stock price is below the option price ✤ Many companies have done that, like Apple, Salomon Brothers, Occidental Petroleum ✤ Why re-pricing? To reduce risk

6. Restricted Stocks ✤ Instead of stock options, some companies make “restricted stock grants” ✤ Restricted stock grants (or restricted stocks) are awarding stock with limits on its transferability for a set time, usually two or three years, but sometimes for the executive’s tenure with the company

7. Some Abusive Compensation Practices 1 ✤ The “Guaranteed Bonus” - The Ultimate Oxymoron ✤ Bonus does not change if performance changes ✤ Deliberate Obfuscation ✤ Hiding compensation benefits from the public ✤ The Christmas Tree ✤ Adding elements to the compensation benefits to make a combination that is not influenced with performance

8. Some Abusive Compensation Practices 2 ✤ Compensation Plans that Are All Upside and No Downside ✤ Plans including any grants of stock or stock options that fail to discount for overall market gains, or that are cushioned against loss of value through compensatory bonuses or re-pricing ✤ Loans ✤ Non-recourse loans: loans that don’t have to be paid ✤ Accelerated Vesting of Options ✤ A form of vesting that takes place at a faster rate than the initial vesting schedule in a company's stock option plan. This allows the option holder to receive the monetary benefit from the option much sooner. If a company decides to undertake accelerated vesting, then it may expense the costs associated with the stock options sooner.

9. Some Abusive Compensation Practices 3 ✤ Manipulation of Earnings to Support Bonuses ✤ Case 1: Income from an asset sale is calculated as earnings to trigger bonus payments ✤ Case 2: Gaming pay-performance formulas by artificially lowering the triggers or other dodges ✤ Huge Disparity between CEO and Other Top Executives ✤ Imputed Years of Service ✤ Small number of years of experience equivalent to a great number

10. Some Abusive Compensation Practices 4 ✤ Excessive Departure Packages ✤ This may include huge compensation packages and forgiveness from mortgages, loans, etc. ✤ Backdating, Bullet-Dodging, and Spring-Loading Options ✤ Executives choose the past date for their grant

11. Some Abusive Compensation Practices 5 ✤ Golden Hellos ✤ Also called “joining bonuses” ✤ Transaction Bonuses ✤ CEOs get bonuses for transactions, like acquisitions and mergers, without considering the performance after that ✤ Gross-Ups and Other Perquisites ✤ Tax payments made by the company on behalf of the executive

12. Some Abusive Compensation Practices 6 ✤ Retirement Benefits ✤ the problem of post-retirement benefits is that they are not subject to the same rigorous disclosure like pre-retirement benefits ✤ Obstacles to Restitution when CEOs Are Overpaid ✤ Companies and shareholder have found it difficult to get restitution when bonuses are paid out based on numbers that are subsequently restated

13. References ✤ Corporate Governance (4th Edition): Monks, R. and Minow, N. 2004. (Publisher: Wiley-Blackwell) ✤ Read more: http://www.investopedia.com/terms/a/acceleratedvesting.asp#ixzz1eu rd71O6 http://www.investopedia.com/terms/a/acceleratedvesting.asp#ixzz1eu rd71O6