Executive Compensation Flashcards
Explain the role of executive compensation as a corporate governance device
EC plays an important corporate governance device to align managers interests and shareholders.
It is used to attract the right talent, motivate them when in executive position and reward managers who maximise shareholder value. Hence, getting the compensation right is very important in maximising SV.
Explain the optimal contracting vs. managerial power debate
This debate highlights differing opinions on how executive pay should work to handle conflicts of interest in companies. (agency theory)
The optimal contracting perspective says manager pay should strongly connect to performance, aligning with share value to address conflicts.
In contrast, the managerial power perspective suggests a weak link between pay and performance, with managers possibly securing higher pay based on negotiation skills rather than actual success.
What is the optimal contracting perspective?
The optimal contracting perspective is when companies create financial incentives to reduce moral hazard in a principal-agent relationship.
These contracts are designed to satisfy a manager’s participation constraint and incentive compatibility constraint
What is meant by managers participation constraint? in optimal contracting
Is the executive remuneration enough to attract talented individuals to a post?
Making sure it’s met is CRUCIAL in motivating the desired managerial behaviour required by the shareholders etc.
What is meant by incentive compatibility constraint? in optimal contracting
Using executive remuneration to motivate managers to make decisions and take actions that maximise shareholder value.
Hence aligning managers and shareholders interests.
What are the three things that Executive compensation does when optimally contracted vs when managerial power is used to decide pay?
Optimally contracted:
1) Attract talented people
2) Motivate them when in the job
3) Reward them for max shareholder value
Managerial Power:
1) Exec compensation is in excess of that required to attract talented individuals to a post
2) EC is in excess of that required to motivate managers
3) EC is weakly related to firm value
What is the managerial power perspective?
When Senior executives use their power to influence how much they are paid and pay composition (structure)
What is the term used when greater managerial power results in greater excess pay?
Rent extraction.
State some components of executive pay packages
Golden hello
Salary
Bonus
Executive Stock Option (ESO)
Restricted stock
Long Term Incentive Plan (LTIP)
Golden parachute
What kind of incentive system does the board of directors want the Executive compensation to encourage?
They aim to create a BALANCED incentive system that considers both short-term and long-term performance within the EC package.
Explain the impact on incentives for Golden Hello, Golden Parachute, Salary and Bonus
Golden hello: Financial motivation for taking the role.
Golden parachute: Offers financial security but may reduce risk perception.
Salary: Offers financial security, but not directly linked to performance.
Bonus: Direct motivation for achieving targets.
Explain the impact on incentives for ESO, Restricted Stock, LTIP
ESO: Motivates executives to improve company performance.
Restricted Stock: Encourages long-term commitment and performance.
LTIP: Ties compensation to long-term success.
Explain what a Golden Hello, Golden Parachute, Salary and Bonus is
GH - one-time payment or bonus offered to executives when they join a new company. It’s designed to attract top talent to a new position.
GP - severance package provided to executives in the event of a change in control, such as a merger or acquisition, leading to their termination.
Salary - The fixed regular payment made to executives for their services.
Bonus - A variable payment given to executives based on meeting certain performance targets or achieving specific goals.
Explain what ESO, Restricted Stock, LTIP is
ESO - Grants executives the right to purchase company stock at a predetermined price, usually in the future.
RS - Executives receive company stock, but ownership is restricted for a certain period. It may have conditions such as performance goals or time-based vesting.
LTIP - A performance-based compensation plan extending over a longer period, often years. It can include various elements like stock options, restricted stock, or other incentives.
What does the evidence say regarding the impact of EC on Acquisitions from Sanders (2001) and Bebchuck et al. (2014)?
- in terms of ESO and pay package
- in terms of GP
Sanders (2001) find that structure of pay package impacts on acquisition behaviour
1) Firms whose CEOs are COMPENSATED with ESOs are more likely to engage in acquisitions and divestments
2) Firms whose CEOs OWN shares are less likely to engage in acquisitions and divestments
Bebchuck et al. (2014):
- Experience negative impact on stock returns when they are adopted
- Associated with higher acquisition premiums
- Overall negative effect on shareholder wealth
- Consistent with managerial power perspective
