BUS 681 Week 5 Assignment

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11 Compensating Executives

Learning Objectives

When you �inish studying this chapter, you should be able to:

11-1. Explain the difference between executive pay and pay for nonexecutives. 11-2. De�ine executive status.

11-3. List the components of executive compensation packages. 11-4. Discuss the principles and processes of setting executive compensation.

11-5. Summarize the executive compensation disclosure rules and the reasons why they have been established. 11-6. Brie�ly explain the executive compensation controversy as it relates to whether U.S. executives are paid too much.

CHAPTER WARM-UP!

If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) to complete the Chapter Warm-Up! and see what you already know. After reading the chapter, you’ll have a chance to take the Chapter Quiz! and see what you’ve learned.

Executive compensation practices in U.S. companies have received substantial attention in the press. Questions about whether executives’ compensation packages are tied to company performance is among the major issues. As we will see, executive pay practices have raised concerns that many executives receive lucrative compensation and bene�its even when company performance falls below shareholder expectations. Many critics have questioned whether such practices may interfere with some executives’ motivation to achieve excellent performance. Other concerns have been voiced by labor unions, which focus on social injustice given the substantial gap in pay between executive and nonexecutive employees, particularly when executive-level management chooses to limit labor through extensive reductions-in-force of nonexecutive employees.

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11.1 CONTRASTING EXECUTIVE PAY WITH PAY FOR NONEXECUTIVE EMPLOYEES

11-1 Explain the difference between executive pay and pay for nonexecutives.

From an economic standpoint, the chief executive of�icer (CEO) is the seller of his or her services, and the compensation committee is the buyer of these services. Under classic economic theory, a reasonable price is obtained through negotiations that are at arm’s length between an informed seller and an informed buyer. An awkward situation can result when the CEO hires a professional compensation director or compensation consultant. In this case, the compensation consultant who makes the recommendation to the compensation committee works for the CEO. In theory, the CEO hires the consultant to perform an objective analysis of the company’s executive pay package and to make whatever recommendations the consultant feels are appropriate. This relationship has the potential to promote a con�lict of interest because of the perceived pressure for the consultant to protect the CEO’s �inancial interests. The irony is that the consultant is often viewed as representing the shareholders’ interests. In a sense, the buyers of the CEO’s services are the shareholders and their representatives, the compensation committee of the board of directors. They tend to act upon the compensation consultant’s recommendation.1

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end1)

It is possible that applying such practices to executives contradicts the main assumptions of performance-based pay, as discussed in Chapters 3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch03#ch03) and 4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04#ch04) . Successful performance triggers merit and incentive awards and the degree of success determines the amount of award. After all, pay-for-performance applies to most nonexecutive employees in U.S. companies. In some instances, executives are rewarded even after they have not performed well, with multimillion dollar awards contingent on their leaving the company. It is not surprising that those instances are often referred to as pay-for-nonperformance or, more harshly, pay-for-failure, and have become increasingly more common events in the world of executive compensation.

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11.2 DEFINING EXECUTIVE STATUS

11-2 De�ine executive status.

It is important to de�ine executive status because it is not an arbitrary designation. In fact, the Internal Revenue Code (IRC), which is the tax code of the United States, provides criteria to guide us in the de�inition of executives as these are key employees and highly compensated employees.

Who Are Executives?

Virtually all the components of executive compensation plans provide favorable tax treatment for both the executive and the company. Who are executives? From a tax regulation perspective, the IRC recognizes two groups of employees who play a major role in a company’s policy decisions: highly compensated employees and key employees. The IRC uses “key employees” to determine the necessity of top-heavy provisions in employer-sponsored quali�ied retirement plans that cover most nonexecutive employees. As an aside, a plan is said to be top-heavy if the accrued bene�its or account balances for key employees exceed 60 percent of the accrued bene�its or account balances for all employees. For clarity, an accrued bene�it is the amount that a participant has earned under the plan’s terms at a speci�ied time.

The IRC uses “highly compensated employees” for nondiscrimination rules in employer-sponsored health insurance bene�its. Although these two designations were created for federal tax rule applications, employees in both groups typically participate in executive compensation and bene�its plans.

Key employees and highly compensated employees hold positions of substantial responsibility. Figure 11-1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec2#ch11�ig01) illustrates the placement of key employees in a typical organizational structure. Although titles vary from company to company and in pay structures, CEOs, presidents, executive vice presidents, vice presidents of functional areas (e.g., human resources), and the directors below them usually meet the criteria for key employees.

Key Employees

The term key employee (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss243) means any employee who at any time during the year is:2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end2)

An of�icer having annual pay of more than $170,000, OR

an individual who for 2015 was either of the following:

a. A 5 percent owner of the employer’s business. b. A 1 percent owner of the employer’s business whose annual pay was more than $150,000.

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FIGURE 11-1 Examples of Key Employees

U.S. Treasury Regulations de�ine the term of�icer used in this de�inition of key employees:3

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end3)

Generally, the term of�icer means an administrative executive who is in regular and continued service. The term of�icer implies continuity of service and excludes those employed for a special and single transaction. An employee who merely has the title of an of�icer but not the authority of an of�icer is not considered an of�icer for purposes of the key employee test. Similarly, an employee who does not have the title of an of�icer but has the authority of an of�icer is an of�icer for purposes of the key employee test.

Highly Compensated Employees

The IRC de�ines a highly compensated employee (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss194) as one of the following during the current year or preceding year:4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end4)

A 5 percent owner at any time during the year or the preceding year, OR

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for the preceding year,

the employee had compensation from the employer in excess of $120,000 in 2015, AND

if the employer so chooses, the employee was in the top-paid group of employees where top-paid employees are the top 20 percent most highly compensated employees.

We have pointed out to the complexity of de�ining executive status. It is worth stepping aside for a moment to consider the real-world challenges of executives. In the Watch It! video, you will hear about the challenges that Microsoft’s CEO Satya Nadella is facing in changing its direction in software applications to become more competitive with other companies.

WATCH IT!

If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) to complete the video exercise titled Microsoft’s Nadella Takes Charge.

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11.3 EXECUTIVE COMPENSATION PACKAGES

11-3 List the components of executive compensation packages.

Executive compensation has both core and employee bene�its elements, much like compensation packages for other employees; however, one noteworthy feature distinguishes executive compensation packages from nonexecutive compensation packages. Executive compensation packages emphasize long-term or deferred rewards over short-term rewards. The main components of executive compensation include (we describe the components here and defer examples to later in this chapter):

Current or annual core compensation

Deferred core compensation: equity agreements

Deferred core compensation: separation agreements

Clawback provisions

Employee bene�its: enhanced protection program bene�its and perquisites

Components of Current Core Compensation

Executive current core compensation packages contain two components: annual base pay and bonuses.

BASE PAY

Base pay is the �ixed element of annual cash compensation. Companies that use formal salary structures may have speci�ic pay grades and pay ranges (Chapter 8 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch08#ch08) ) for nonexempt employees and exempt employees, including supervisory, management, professional, and executive jobs, with the exception of the CEO.

Chief executive of�icer jobs do not fall within formal pay structures for two reasons. First, CEOs’ work is highly complex and unpredictable. It is not possible to specify discrete responsibilities and duties. The choice of competitive strategy by CEOs and other executives and the in�luence of external and internal market factors make it impossible to describe CEOs’ jobs. Second, setting CEO compensation differs dramatically from the rational processes compensation professionals use to build market-competitive pay structures (Chapter 7 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch07#ch07) ). We will discuss agency theory, tournament theory, and social comparison theory later as explanations for setting CEO compensation.

In most cases, annual base pay represents a relatively small part of a CEO’s total compensation for two reasons. First, it typically takes years before the fruits of the CEOs’ strategic initiatives are realized. Second, the IRS limits the amount of annual salary a company may exclude as a business expense. Only the �irst $1 million annually for an executive’s pay may be excluded from the company’s income tax liability as long as the pay is not deemed to be pay-for-performance.5

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end5) Base pay would fall under this rule. This ruling was put into place to keep companies from boosting CEO annual pay to astronomical levels for the purposes of tax savings.

BONUSES

Bonuses represent single pay-for-performance payments companies use to reward employees for achievement of speci�ic, exceptional goals. As discussed in previous chapters, compensation professionals design bonuses for merit pay programs (Chapter 3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch03#ch03) ), gain sharing plans and referral plans (Chapter 4 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch04#ch04) ), and sales incentive compensation programs (Chapter 8 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch08#ch08) ). Bonuses also represent a key component of executive compensation packages.

Companies’ compensation committees recommend bonus awards to boards of directors for their approval (as we will discuss later in this chapter). Four types of bonuses are common in executive compensation:

Discretionary bonus

Performance-contingent bonus

Predetermined allocation bonus

Target plan bonus

As the term implies, boards of directors award discretionary bonuses (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss109) to executives on an elective basis. They weigh four factors in determining the amount of discretionary bonus: company pro�its, the �inancial condition of the company, business conditions, and prospects for the future. For example, boards of directors may award discretionary bonuses to executives when a company’s position in the market is strong.

Executives receive performance-contingent bonuses (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss331) based on the attainment of speci�ic performance criteria. The performance appraisal system for determining bonus awards is often the same appraisal system used for determining merit increases or general performance reviews for salary (Chapter 3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch03#ch03) ).

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Unlike the previous executive bonuses, the total bonus pool for the predetermined allocation bonus (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss346) is based on a �ixed formula. The central factor in determining the size of the total bonus pool and bonus amounts is company pro�its.

The target plan bonus (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss439) ties bonuses to executives’ performance. The bonus amount increases commensurately with performance. Executives do not receive bonuses when their performance falls below minimally acceptable standards. The target plan bonus differs from the predetermined allocation bonus in an important way: Predetermined allocation bonus amounts are �ixed, regardless of how well executives perform.

SHORT-TERM INCENTIVES

Companies award short-term incentive compensation to executives to recognize their progress toward ful�illing competitive strategy goals. Executives may participate in current pro�it sharing plans and gain sharing plans. Whereas short-term objectives reward nonexempt and lower-level management employees for achieving major milestone work objectives, short-term incentives applied to executives are designed to reward them for meeting intermediate performance criteria. The performance criteria relate to the performance of a company as dictated by competitive strategy. Change in the company’s earnings per share over a 1-year period, growth in pro�its, and annual cost savings are criteria that may be used in executives’ short-term incentive plans.

Short-term incentive compensation programs usually apply to a group of select executives within a company. The plan applies to more than one executive because the synergy that results from the efforts and expertise of top executives in�luences corporate performance. The board of directors distributes short- term incentive awards to each executive based on rank and compensation levels. Thus, the CEO will receive a larger performance award than will the executive vice president, whose position is lower in the company’s structure than the CEO’s position.

For example, let’s assume that the CEO and executive vice president of a chain of general merchandise retail stores have agreed to lead the corporation as the lowest-cost chain of stores in the general merchandise retail industry. The CEO and executive vice president establish a 5-year plan to meet this lowest-cost competitive strategy. The vice president of compensation recommends that the company adopt a gain sharing program to reward top executives for contributing to the cost reduction objective. After 1 year, the complementary decisions made by the CEO and executive vice president have enabled the corporation to save $10,000,000. The board of directors agrees that the executives’ collaborative decisions led to noteworthy progress toward meeting the lowest-cost strategy and award the CEO 2 percent of the annual cost savings ($200,000) and the executive vice president 1 percent ($100,000).

Components of Deferred Core Compensation

Deferred compensation (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss96) refers to an agreement between an employee and a company to render payments to an executive at a future date. Deferred compensation is a hallmark of executive compensation packages. As an incentive, deferred compensation is supposed to create a sense of ownership, aligning the interests of the executive with those of the owners or shareholders of the company over the long term. The rationale for creating an ownership stake for the executive is explained by agency theory, which we will discuss later in this chapter. Broadly speaking, there are two general types of deferred compensation plans. The �irst, equity plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss134) , provides an executive with ownership stakes in the company through a variety of mechanisms, including various stock option plans and stock purchase plans. The second, separation agreements (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss404) , guarantee that an executive will receive a lucrative compensation package upon employment termination.

The prevalent way in which companies create ownership interests, also known as equity interests, is by making the executive an owner of the company. Company stock ownership or company stock options create an equity interest in the company.

Equity Agreements

Company stock and stock options provide the foundation for equity agreements. Company stock (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss57) represents total equity of the �irm. Company stock shares (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss58) represent equity segments of equal value. Equity interest increases positively with the number of stock shares. Stocks are bought and sold every business day in a public stock exchange. The New York Stock Exchange is among the best-known of the stock exchanges. Table 11-1 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#ch11tab01) lists basic terminology pertaining to stocks.

Companies design executive stock compensation plans to promote an executive’s sense of ownership of the company. A sense of ownership should presumably motivate executives to strive for excellent performance. Stock value generally increases with gains in company performance. In particular, a company’s stock value rises in response to reports of pro�it gains; however, factors outside executives’ control often in�luence stock prices despite executives’ performance. For example, forecasts of economy-wide recession, increases in the national unemployment rate, and threats to national security or political instability are often associated with declines in stock value.

TABLE 11-1 Employee Stock Terminology

Stock option. A right granted by a company to an employee to purchase a number of stocks at a designated price within a speci�ied period of time. Stock grant. A company’s offering of stock to an employee. Exercise of stock grant. An employee’s purchase of stock, using stock options. Disposition. Sale of stock by the stockholder. Fair market value. The average value between the highest and lowest reported sales price of a stock on the New York Stock Exchange on any given date. The Internal Revenue Service speci�ies whether an option has a readily ascertainable fair market value at grant. An option has a readily ascertainable fair market value if the option is actively traded on an established stock exchange at the time it is granted.

Five particular forms of deferred (stock) compensation include:

Stock options

Restricted stock and restricted stock units

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Stock appreciation rights

Phantom stock plans

Employee stock purchase plans

STOCK OPTIONS

Broadly, there are two particular types of stock options—incentive stock options and nonstatutory stock options. Incentive stock options (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss213) entitle executives to purchase their companies’ stock in the future at a predetermined price. The predetermined price usually equals the stock price at the time an executive is granted the stock option. In effect, executives are purchasing the stocks at a discounted price. Executives generally exercise their option to purchase the stock after the price has increased dramatically. An executive receives capital gains (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss37) as the difference between the stock price at the time of purchase and the lower stock price at the time an executive receives the stock option. Executives receive income tax bene�its by participating in incentive stock option plans. They are not required to pay tax on the capital gains until they sell their stock shares. The tax rate for such transactions is called the capital gains rate. It is typically substantially lower than the executive’s ordinary income tax rate, further adding incentive value to incentive stock options. If stock price at the time of disposition were lower than at the price of the stock option grant, the executive would experience a capital loss (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss38) .

Much like incentive stock options, companies award stock options to executives at discounted prices. In contrast to incentive stock options, nonstatutory stock options (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss299) do not qualify for favorable tax treatment. Executives pay income taxes on the difference between the discounted price and the stock’s fair market value at the time of the stock grant, not at the time of disposition, and they do so at their ordinary income tax rate. They do not pay taxes in the future when they choose to exercise their nonstatutory stock options.

Nonstatutory stock options do provide executives an advantage. Executives’ tax liability is ultimately lower over the long term: Stock prices generally increase over time. As a result, the capital gains will probably be much greater in the future when executives exercise their options rather than when their companies grant these options.

RESTRICTED STOCK PLANS, RESTRICTED STOCK UNITS, AND PERFORMANCE STOCK AWARDS

Under restricted stock plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss378) , a company may grant executives with stock options at market value or discounted value, or they may provide stock. Under restricted stock plans, executives do not have any ownership control over the disposition of the stock for a predetermined period, often many years. This predetermined period is known as the vesting period, much like vesting rights associated with employer-sponsored retirement plans (Chapter 9 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch09#ch09) ). Alternatively, companies may provide executives with restricted stock units. Restricted stock units (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss379) are shares of company stock that are awarded to executives at the end of the restriction period.

Similar to restricted stock plans and restricted stock units in terms of the vesting period, a company may choose to add to the vesting period a performance criterion for determining whether to award stock options or stock units. This type of equity agreement is referred to as a performance plan (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss332) . A company’s board of directors determines the performance criteria. For example, a company’s earnings per stock share is often used. Coca-Cola Company recently modi�ied its executive-level and top-management equity agreements to follow performance plan standards. These leaders will receive fewer stock shares, but additional performance share units. One of the main reasons for this change is shareholders’ dissatisfaction with the company’s weak performance in the U.S. market.6

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end6)

STOCK APPRECIATION RIGHTS

Stock appreciation rights (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss427) provide executives income at the end of a designated period, much like restricted stock options; however, executives never have to exercise their stock rights to receive income. The company simply awards a bonus payment to executives based on the difference in stock price between the time the company granted the stock rights at fair market value to the end of the designated period, permitting the executives to keep the stock. Executives pay tax on any income, from gains in stock value to when they exercise their stock rights,7 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end7) presumably after retirement when their tax rates are lower.

PHANTOM STOCK PLANS

A phantom stock (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss336) plan is a compensation arrangement whereby boards of directors promise to pay a bonus in the form of the equivalent of either the value of company shares or the increase in that value over a period of time. Phantom stock plans are similar to restricted stock plans because executives must meet speci�ic conditions before they can convert these phantom shares into real shares of company stock.8 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end8) There are generally two conditions. First, executives must remain employed for a speci�ied period, usually several years. Second, executives must retire from the company. Upon meeting these conditions, executives receive income equal to the increase in the value of company stock from the date the company granted the phantom stock to the conversion date. Phantom stock plans provide executives with tax advantages. Executives pay taxes on the capital gains after they convert their phantom shares to real shares of company stock during retirement.

EMPLOYEE STOCK PURCHASE PLANS

A company may choose to offer a formal employee stock purchase plan that allows participating employees to purchase stock after a designated period of time. In anticipation of making a stock purchase, employees set aside money through payroll deduction for this speci�ic purpose during the offering period, which is the point in time when they may purchase the employer’s stock based on the money set aside in their accounts. The span of time over which employees are permitted to contribute to their accounts is referred to as the offering period (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss306) . Companies have the option of setting up employee stock purchase plans as quali�ied or nonquali�ied. To qualify for favorable tax treatment, companies’ plans must meet several criteria. For example, all full-time employees with 2 or more years of service must be allowed to participate.

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Separation Agreements

GOLDEN PARACHUTES

Most executives’ employment agreements contain a golden parachute clause. Golden parachutes (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss175) provide pay and bene�its to executives after a termination that results from a change in ownership or corporate takeover, that is, the merger or combining of two separate companies. Approximately 80 percent of Standard & Poor’s 500 companies offer golden parachute packages to CEOs who are replaced due to corporate takeover.9

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end9) For example, Compuware, which developed software for use on mainframe computers, was taken over by a private equity �irm Thoma Bravo, LLC. in 2014. The top six executives of the company held golden parachute agreements equaling approximately $23 million in cash, stock, and other bene�its.10 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end10) Among these top executives, former CEO Bob Paul’s golden parachute was valued at approximately $6.6 million. Boards of directors often include golden parachute clauses for at least three reasons. First, golden parachutes limit executives’ risks in the event of these unforeseen events. Second, golden parachutes promote recruitment and retention of talented executives. Third, in the event that a takeover bid would bene�it the company, it is possible that a CEO would work against it in order to save his or her job.

Companies bene�it from golden parachute payments because they can treat these payments as business expenses. This means that companies can reduce their tax liability by increasing the parachute amount. The total value of golden parachutes came to exceed executives’ annual income levels by far. Public outcry led to government-imposed intervention that limited tax bene�its to companies. Companies may generally receive tax deductions on golden parachutes.

PLATINUM PARACHUTES

In an ideal world, CEOs will perform on an exemplary basis, making decisions to drive up company pro�its. As you know, we do not live in a perfect world; sometimes, CEOs do not perform their jobs well and companies lose out on pro�it opportunities. After a period of unsatisfactory performance as determined by shareholders and other company executives, CEOs may often be terminated even before the expiration of their employment contracts. Many companies reach agreements with CEOs to terminate employment, awarding a platinum parachute as an incentive. Platinum parachutes (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss339) are lucrative awards that compensate departing executives with severance pay, continuation of company bene�its, and even stock options. Companies typically use platinum parachutes to avoid long legal battles or critical reports in the press, essentially by paying off a CEO to give up his or her post. For example, Louis Chenevert resigned from United Technologies amid growing criticism from investors that he had become disengaged from the business. He left the company with a platinum parachute worth $195 million including approximately $136.3 million in stock options and about $31 million in pension bene�its.11

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end11) Apart from this example, it is important to reiterate that golden parachutes became common when hostile corporate takeovers were occurring in large numbers during the 1980s and 1990s. As such activity slowed down, many companies continued to offer golden parachutes, but extended the use for a CEO’s termination for other reasons, such as poor performance. For this purpose, it is not uncommon to see the terms golden parachute and platinum parachute used interchangeably.

Clawback Provisions

Clawback provisions (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss46) in CEO employment contracts allow boards of directors to take back performance-based compensation if they were to subsequently learn that performance goals were not actually achieved, regardless of whether the CEO was responsible for performance falling short of target levels. Increasingly, these provisions are becoming more common because of the increasing scrutiny of CEO compensation packages by the public and shareholders, particularly since the global �inancial crisis in the late 2000s. For example, Wilmington Trust Corporation rescinded more than $1.8 million in compensation from Chief Executive Donald Foley. As it turns out, Wilmington’s purchase of another bank at a price below market value lowered the overall value of the combined company. Government agencies may also follow suit. For instance, Department of Veterans Affairs (VA) Eric Shinseki rescinded a monetary bonus from Sharon Helman, Director of the Phoenix VA system.12

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end12) Shinseki acted on allegations of falsi�ied data on delays in doctor appointments, and the death of some veterans which occurred while awaiting care. More broadly, well-publicized corporate accounting scandals led to tighter accounting standards. Modi�ied corporate tax law put tighter restrictions on deferred compensation payouts to prevent corporate executives from siphoning money out of their corporations. There speci�ically was a rash of executives withdrawing deferred compensation money before their companies went bankrupt. Perhaps the most well-known scandal occurred at Enron. In response to corporate accounting scandals, the Securities and Exchange Commission (SEC) administered the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act is perhaps the most signi�icant legislation because it imposes rigorous requirements for companies’ �inancial disclosure to limit the chance that covert misuses of corporate funds will occur. In 2002, President George W. Bush strengthened the oversight of the SEC when he signed the Sarbanes-Oxley Act of 2002 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss392) into law. The act mandates a number of reforms to enhance corporate responsibility, enhance �inancial disclosures, and combat corporate and accounting fraud in response to corporate accounting scandals, such as in Enron, Tyco, and other large U.S. corporations. The act established Public Company Accounting Oversight Board (PCAOB) to oversee the activities of the auditing profession.

Employee Bene�its: Enhanced Protection Program Bene�its and Perquisites

Executives receive discretionary bene�its like other employees; however, executives’ discretionary bene�its differ in two ways. First, protection programs include supplemental coverage that provides enhanced bene�it levels. Second, the services component contains bene�its exclusively for executives. These exclusive executive bene�its are known as perquisites (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss334) or perks (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss333) .

ENHANCED PROTECTION PROGRAM BENEFITS

Supplemental life insurance and supplemental executive retirement plans distinguish protection programs for executive employees from protection programs for other employees. As discussed in Chapter 9 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch09#ch09) , employer-provided life insurance protects employees’ families by paying a speci�ied amount to an employee’s bene�iciaries upon an employee’s death. Most policies pay some multiple of the employee’s salary (e.g., bene�its paid at twice the employee’s annual salary). In addition to regular life insurance, executives receive supplemental life insurance (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss436) protection that pays an additional monetary bene�it. Companies design executives’ supplemental life insurance protection to meet two objectives.13

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(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end13) First, supplemental life insurance increases the bene�it to designated bene�iciaries upon their deaths. Life insurance programs may be designed to provide greater bene�its than standard plans usually allow. Second, these programs provide executives with favorable tax treatments.

Supplemental retirement plans (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss437) are designed to restore bene�its restricted under quali�ied plans. In Chapter 9 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch09#ch09) , we discussed some of the characteristics of quali�ied plans. A quali�ied plan generally entitles employees to favorable tax treatment of the bene�its they receive upon their retirement. Any investment income that is generated in the pension program is not taxed until the employee retires.

The IRS limited the annual earnings amount for determining quali�ied plan bene�its to $265,000 in 2015 (indexed for in�lation, in increments of $5,000). In general, all annual earnings greater than this level cannot be included in de�ined bene�it plan formulas or the calculation of annual additions to de�ined contribution plans. In addition, the IRS limits the annual bene�it amounts for de�ined bene�it plans to the lesser of $210,000 in 2015, indexed for in�lation, or 100 percent of the highest average compensation for 3 consecutive years.14 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end14) For example, an executive’s three highest annual salaries are $690,000, $775,000, and $1,100,000. The average of these three highest salaries is $855,000. Of course, $210,000 is less than $855,000; therefore, an executive’s retirement income based on the company’s quali�ied pension plan cannot exceed $210,000 adjusted for in�lation.

A supplemental retirement plan can make up this difference. For illustrative purposes, let’s assume that the annual bene�it under a quali�ied pension plan is 60 percent of the �inal average salary for the past 15 years of service, which is $400,000. Based on this formula, the executive should receive an annual retirement bene�it of $240,000 ($400,000 × 60 percent). This annual bene�it exceeds $210,000 (the statutory limit for quali�ied retirement plans). Because of the statutory limit, companies may offer a supplemental executive retirement plan that provides the difference between the value derived from the pension formula ($240,000) and the statutory limit ($210,000). In this example, the executive would receive a supplemental annual retirement bene�it of $30,000.

PERQUISITES

Executive perquisites are an integral part of executive compensation. Perquisites cover a broad range of bene�its, from free lunches to the free use of corporate jets. Table 11-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#ch11tab02) lists common executive perks. Perquisites serve at least four purposes. First, these bene�its recognize executives’ attained status. Membership in an exclusive country club reinforces executives’ attained social status. Second, executives use perks for personal comfort or as a business tool. For example, a company may own a well-appointed cabin in Vail, Colorado. Executives may use the cabin for rest and relaxation or as a place to court new clients or close a lucrative business deal. Arranging relaxing weekends in Vail bene�its executives and their families and provides executives opportunities to develop rapport with prospective clients. Third, the use of corporate aircraft may be considered a security measure for executives who are public �igures.15

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end15) The CEOs from a majority of Fortune 100 companies have this perk, with an average annual cost approaching $150,000.16 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end16) Promoting security goes beyond the use of corporate jets. A variety of security measures have cost Fortune 100 companies a median value of $28,618 in 2013. The cost ranged from as low as $284 for Phillips 66 CEO to as high as $1.6 million for Amazon.com (http://Amazon.com) ’s CEO.17

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end17) Fourth, particular perks, such as having a chauffeur or tax and �inancial planning services, permit executives to have fewer distractions, providing for more opportunities to attend to work matters.

TABLE 11-2 Common Executive Perks

Company cars

Supplemental life insurance

Legal services (e.g., income tax preparation)

Recreational facilities (e.g., country club and athletic club memberships)

Security detail (protection)

Travel perks (e.g., use of corporate jet)

Despite the rationale for providing lucrative perks, many companies have begun scaling back offerings. For example, Regeneron Pharmaceuticals decided to reduce perks for its top executives.18 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end18) The company is eliminating perks such as car allowances, credit card fees, and its CEO’s golf membership, costing $18,500 per year.

It is possible that companies will provide cash in lieu of perquisites because of stricter reporting requirements by the Securities and Exchange Commission. Particularly after the corporate scandals at Enron and other corporations, company shareholders expect management to display greater accountability for the nonbusiness use of such company property as corporate jets. Since 2008, companies have had to report perks valued at $10,000 or more apiece.

A survey of executive compensation practices in Fortune 500 companies revealed that a signi�icant number of companies, about 85 percent, offer executive perks, but fewer of them than in the past.19 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end19) In particular, between 2008 and 2013, the percentage of companies offering three or more executive perks dropped from 60 percent to 33 percent. In the same time frame, the number of companies that eliminated executive perks altogether jumped from 6 percent to 15 percent. The prevalence of fewer perks offerings may be due to greater economic uncertainties and the recent requirement that companies report perks valued at $10,000, or more, apiece. Greater shareholder scrutiny is also a contributing factor, as more emphasis is given on performance-based rewards.

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11.4 PRINCIPLES AND PROCESSES FOR SETTING EXECUTIVE COMPENSATION

11-4 Discuss the principles and processes of setting executive compensation.

We discussed the processes compensation professionals use to reward performance (e.g., merit pay and alternative incentive pay methods) and acquisition of job-related knowledge and skills (e.g., pay-for-knowledge and skilled-based pay) in previous chapters. Although pay-for-performance is the public rationale for setting executive compensation, reality is often quite different. Three alternative theories explain the principles and processes for setting executive compensation: agency theory, tournament theory, and social comparison theory. We will begin by discussing the key players in setting executive compensation.

The Key Players in Setting Executive Compensation

Different individuals and groups participate in setting executive compensation. They include compensation consultants, compensation committees, and boards of directors. Each plays a different role in setting executive compensation.

EXECUTIVE COMPENSATION CONSULTANTS

Executive compensation consultants (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss139) usually propose several recommendations for alternate pay packages. Executive compensation consultants are often employed by large consulting �irms that specialize in executive compensation or advise company management on a wide variety of business issues. The regulations involving executive compensation plans are extremely complex. To understand them fully requires expertise often found in leading executive compensation and bene�its consulting �irms. Some of the leading and most well-respected �irms in this area include the following:

Frederic W. Cook & Company (www.fwcook.com (http://www.fwcook.com) )

The Hay Associates (www.haygroup.com (http://www.haygroup.com) )

Pearl Meyer & Partners (www.pearlmeyer.com (http://www.pearlmeyer.com) )

Towers Watson (www.towerswatson.com (http://www.towerswatson.com) )

William M. Mercer (www.mercer.com (http://www.mercer.com) )

Consultants make recommendations about what and how much to include in executive compensation packages based on strategic analyses, which entail an examination of a company’s external market context and internal factors. Examples of external market factors include industry pro�ile, information about competitors, and long-term growth prospects. Financial condition is the most pertinent internal factor regarding executive compensation. Strategic analyses permit compensation consultants to see where their client company stands in the market based on external and internal factors. Strong companies should be able to devote more �inancial resources to fund lucrative executive compensation programs than weaker companies. More often than not, executive compensation consultants �ind themselves in con�lict-of-interest situations:

Ostensibly, compensation consultants were hired by the CEO to perform an objective analysis of the company’s executive pay package and to make whatever recommendations the consultant felt were appropriate. In reality, if those recommendations did not cause the CEO to earn more money than he was earning before the compensation consultant appeared on the scene, the latter was rapidly shown the door.20

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end20)

Executive compensation consultants’ professional survival may depend on recommending lucrative compensation packages. Recommending the most lucrative compensation packages will quickly promote a favorable impression of the consultant among CEOs, leading to future consulting engagements.

Since 2008, the Securities and Exchange Commission rulings require companies to include the identity of the consulting �irm in public disclosure statements. This ruling has created concerns about possible con�licts of interest for consulting �irms that also provide consulting services in other areas (e.g., performance management and change management) for the same client �irms. Executive compensation consulting represents just one of many possible areas of management consulting. The con�lict potentially arises when a consultant intentionally recommends a more-lucrative-than-warranted executive compensation package in the hope of gaining management favor and additional other management consulting opportunities. Of course, compensation consulting �irms are concerned about the public image of possible con�licts of interest and have considered a variety of practices to ensure the integrity of their recommendations to client �irms. For example, there has been some speculation that executive consulting practices will be spun off into independent businesses. Many companies are concerned about their own public image and have instituted policies to prevent compensation consultants from conducting other work for management.

BOARD OF DIRECTORS

A board of directors (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss30) represents shareholders’ interests by weighing the pros and cons of top executives’ decisions. Boards of directors have approximately 15 members. These members include CEOs and top executives of other successful companies, distinguished community leaders, well-regarded professionals (e.g., physicians and attorneys), and possibly a few top-level executives of the company.

Boards of directors give �inal approval of the compensation committee’s recommendation. Some critics of executive compensation have argued that CEOs use compensation to co-opt board independence.21 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end21) CEOs often nominate candidates for board membership, and their nominations usually lead to candidates’ placement on the board. Board members receive compensation for their service to the boards. It’s not uncommon for a board member to earn more than $50,000 per year plus a fee ($10,000 or more) for each board meeting attended. Along with monetary and stock compensation, companies are using such bene�its as medical insurance, life insurance, and retirement programs to attract top-notch individuals to join boards of directors. In general, board members’ failure to cooperate with CEOs may lead either to fewer bene�its or their removal.

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The board determines the pay of the CEO. But who determines the pay of the outside directors? Here, a sort of formal Japanese Kabuki has developed. The board of directors determines the pay of the CEO, and for all practical purposes, the CEO determines the pay of the board of directors. Is it any accident, then, that there is a statistical relationship between how highly the CEO is paid and how highly his outside directors are paid?22

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end22)

As we will discuss shortly, recent changes in Securities and Exchange Commission rulings and the passage of the Dodd-Frank Act have increased the transparency of how executives are compensated, as well as board members’ accountability for approving sound executive compensation packages— supportive of shareholders’ best interests.

COMPENSATION COMMITTEE

Board of directors members within and outside the company make up a company’s compensation committee (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss63) . Outside board members serve on compensation committees to minimize con�lict of interest. Thus, outside directors usually are the committee’s membership majority.

Compensation committees perform three duties. First, compensation committees review consultants’ alternate recommendations for compensation packages. Second, compensation committee members discuss the assets and liabilities of the recommendations. The complex tax laws require compensation committees to consult compensation experts, legal counsel, and tax advisors. Third, based on these deliberations, the committee recommends the consultant’s best proposal to the board of directors for its consideration.

Theoretical Explanations for Setting Executive Compensation

Three prominent theories describe the processes related to setting executive compensation: agency theory, tournament theory, and social comparison theory. The following discussion provides concrete interpretations of these theories. In addition to the works cited throughout this chapter, several excellent scholarly journal articles provide full explanations of these theoretical frames as applied to executive compensation.23

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end23)

AGENCY THEORY

Ownership is distributed among many thousands of shareholders in such large companies as Microsoft, General Electric, General Motors, and IBM. For example, owning at least one share of stock in IBM bestows ownership rights in IBM. Each shareholder’s ownership is quite small, amounting to far less than 1 percent. Inability to communicate frequently or face to face to address business concerns is a major disadvantage of thousands of shareholders.

Under agency theory (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss12) , shareholders delegate control to top executives to represent their ownership interests; however, top executives usually do not own majority shares of their companies’ stocks. As a result, executives usually do not necessarily share the same interests as the collective shareholders. These features make it possible for executives to pursue activities that bene�it themselves rather than the shareholders. The actions of executives on behalf of their own self-interest are known as the agency problem (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss11) .24

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end24) Executives may speci�ically emphasize the attainment of short-term gains (e.g., increasing market share through lower costs) at the expense of long-term objectives (e.g., product differentiation). Boards of directors may be willing to provide executives generous annual bonuses for attaining short-term gains.

Shareholders negotiate executive employment contracts with executives to minimize loss of control. Executive employment contracts de�ine terms of employment pertaining to performance standards and compensation, speci�ically current and deferred compensation and bene�its. The main shareholder objective is to protect the company’s competitive interests. Shareholders use compensation to align executives’ interests with shareholders’ interests. As discussed earlier, boards of directors award company stock to align executives’ interests with shareholders’ interests.

TOURNAMENT THEORY

Tournament theory (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss452) casts lucrative executive compensation as the prize in a series of tournaments or contests among middle- and top-level managers who aspire to become CEOs.25

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end25) Winners of the tournament at one level enter the next tournament level. In other words, an employee’s promotion to a higher rank signi�ies a win, and more lucrative compensation (e.g., higher base pay, incentives, enhanced bene�its, and perks) represents the prize. The ultimate prize is promotion to CEO and a lucrative executive compensation package. The chance of winning competitions decreases dramatically as employees rise through the ranks: There are fewer positions at higher levels in corporate hierarchical structures. Figure 11-2 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#ch11�ig02) depicts a visual representation of CEO compensation as a tournament.

SOCIAL COMPARISON THEORY

According to social comparison theory (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss417) , individuals need to evaluate their accomplishments, and they do so by comparing themselves to similar individuals.26

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end26) Demographic characteristics (e.g., age or race) and occupation are common comparative bases. Individuals tend to select social comparisons who are slightly better than themselves.27

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end27) Researchers have applied social comparison theory to explain the processes for setting executive compensation.28 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end28)

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FIGURE 11-2 CEO Compensation as a Tournament

As we discussed earlier, compensation committees play an important role in setting executive compensation, and compensation committees often include CEOs from other companies of equal or greater stature. Based on social comparison theory, compensation committee members probably rely on their own compensation packages and the compensation packages of CEOs in companies of equal or greater stature to determine executive compensation.

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11.5 EXECUTIVE COMPENSATION DISCLOSURE RULES

11-5 Summarize the executive compensation disclosure rules and the reasons why they have been established.

Disclosure of executive compensation components and engagement of shareholder opinion set executive compensation practices apart from compensating other employee groups. Two laws, in particular, are responsible for these requirements: Securities and Exchange Act of 1934 and the Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act).

Securities and Exchange Act of 1934

Companies that sell and exchange securities (e.g., company stocks and bonds) on public stock exchanges are required to �ile a wide variety of information with the Securities and Exchange Commission (SEC) (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss398) , including executive compensation practices. One of the main goals is to help prospective investors understand the �inancial matters of importance to themselves. The SEC is a nonpartisan, quasi-judicial federal government agency with responsibility for administering federal securities laws. The Securities Exchange Act of 1934 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss399) applies to the disclosure of important company �inancial information as well as information about executive compensation practices. Each year, companies are required to �ile a Form 10-K, which contains a detailed picture of a company’s business, the risks it faces, and the operating and �inancial results for the �iscal year. In addition, the 10-K includes management’s perspective on their business results and what is in�luencing them.

Companies are also required to complete a De�initive Proxy Statement (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss100) under Section 14A of the Securities Exchange Act, typically referred to as a DEF 14A. It reveals detailed information about the compensation of the CEO and Named Executive Of�icers (NEOs) (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss288) , who generally are the four most highly compensated of�icers after the CEO. Within the DEF 14A, companies must disclose multiple types of information, which are listed in Table 11-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11tab03) . The information should be presented in narrative and tabular form. The narrative is referred to as the Compensation Discussion and Analysis (CD&A) (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss64) where it must present an unambiguous explanation of all executive compensation information contained in the tables. Disclosing detailed information about executive compensation should increase the accountability of company boards of directors for executive compensation policies and decisions. Failure to comply with SEC reporting rules can lead to hefty monetary penalties. For example, Polycom Inc. paid the SEC $750,000 to settle civil charges that the company failed to report when a CEO used nearly $200,000 for personal perks.29 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end29)

TABLE 11-3 Securities and Exchange Commission Disclosure Requirements for Executive Compensation

Stock option and stock appreciation right tables

Long-term incentive plan table

Pension plan table

Performance graph comparing the company’s stock price performance against a market index and a peer group

Report from the compensation committee of the board of directors explaining compensation levels and policies

Description of the directors’ compensation, disclosing all amounts paid or payable

Disclosure of certain employment contracts and golden parachutes

TABLE 11-4 2008 Summary Compensation Table

Annual Compensation Long-term Compensation All Other Compensation ($)

Keith S. Sherin,

Vice Chairman and CFO 2008 $1,500,000 $2,550,000 $2,987,493

2007 $1,354,167 $3,000,000 $3,076,095

2006 $1,225,000 $2,550,000 $2,808,919

Michael A. Neal,

Vice Chairman 2008 $1,650,000 $2,900,000 $3,512,898

2007 $1,550,000 $3,880,000 $4,212,201

2006 $1,400,000 $3,300,000 $3,906,929

John G. Rice,

Vice Chairman 2008 $1,650,000 $2,700,000 $3,659,090

Source: Based on Summary Compensation Table: 17 C.F.R 229.402(b), as amended November 29, 1993, effective January 1, 1994.

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Annual Compensation Long-term Compensation All Other Compensation ($)

2007 $1,550,000 $3,000,000 $4,406,900

2006 $1,400,000 $2,550,000 $4,122,437

Brackett B. Denniston,

Senior Vice President, General Counsel and Secretary 2008 $1,200,000 $1,850,000 $2,284,110

David R. Nissen,

Former President & CEO, GE Money 2008 $1,350,000 $1,310,000 $6,777,594

Robert C. Wright,

Former Vice Chairman 2008 $916,667 $2,783,000 —

2007 $2,750,000 $7,590,000 $1,943,665

2006 $2,500,000 $6,900,000 $2,516,712 Source: Based on Summary Compensation Table: 17 C.F.R 229.402(b), as amended November 29, 1993, effective January 1, 1994.

DEF 14As must be �iled each year in advance of the annual meeting of the board of directors and company shareholders. This information is available to the public through a company’s annual report, which can be found on its website. Also, the SEC offers a database on its site (http://www.sec.gov (http://www.sec.gov) ) referred to as EDGAR, which contains all of the required �ilings.

There are several tables contained within the DEF 14A, but the most important here is the Summary Compensation Table,30

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end30) which discloses compensation information for the CEO and the four most highly paid executives over a 3-year period. As you can see in Table 11-3 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11tab03) , the Summary Compensation Table for General Electric covers the compensation paid to the named executive of�icers during the past completed �iscal year and the two preceding �iscal years. The table contains two main subheadings: annual compensation and long-term compensation. Annual compensation includes salary (i.e., base pay), bonus, and other annual compensation. Long-term compensation includes restricted stock awards, stock appreciation rights, and long-term incentive payouts. The last column, “All Other Compensation ($),” is a catchall column to record other forms of compensation. Information in this column must be described in a footnote.

In 2008, the SEC unveiled additional rules for disclosing executive compensation. These rules require that companies reveal how much executives are paid, making such previously hard-to-�ind information as pension and estimated severance package totals transparent. Although the new rules represent a substantial improvement in pay disclosure, the SEC made a revision that resulted in a less-meaningful disclosure of stock options.

In 2009, the SEC chairperson announced further changes in the disclosure of executive compensation in a company’s Summary Compensation Table. The change pertains to the reported value for stock options and stock awards. The SEC disclosure rules show components of compensation previously hidden as well as provide clarity into elements of compensation already disclosed. The most signi�icant changes follow:

Total. The Summary Compensation Table of a company’s proxy will now have a column that adds up and displays the total compensation an executive received for the previous year. In the SEC pay database this year, this is labeled SEC Total.

Change in Pension Value and Nonquali�ied Deferred Compensation. This column in the Summary Compensation Table shows the increase in actuarial value to the executive of�icer of all de�ined bene�it pension plans and earnings on nonquali�ied deferred compensation plans.

All Other. This column captures compensation that does not �it in any other column of the Summary Compensation Table, including perquisites and other personal items (e.g., aircraft usage, car service, and club memberships). Each item of compensation included in All Other that exceeds $10,000 will now be separately identi�ied and quanti�ied in a footnote.

Pension Bene�its. The new rules require companies to disclose the present value of accumulated pension bene�its, showing the total lump sum amount of money an executive would receive in retirement.

Severance Bene�its. Companies must disclose any termination or change-in-control agreements with executives. They must disclose the speci�ic circumstances that will trigger payment and the estimated total payments and bene�its provided for each circumstance.

The following table describes each component of the All Other Compensation column.

2008 All Other Compensation Table

We provide our named executives with additional bene�its, re�lected in the table below for 2008, that we believe are reasonable, competitive, and consistent with the company’s overall executive compensation program. The costs of these bene�its constitute only a small percentage of each named executive’s total compensation.

Name of Executive

Other Bene�itsa

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11fn2)

($)

Tax Paymentsb

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11

($)

Immelt 212,293 0

a See the 2008 Other Bene�its Table for additional information. b This column reports amounts reimbursed for the payment of taxes with respect to �inancial counseling, tax preparation services, and the personal use of car service. Starting in 20 services. c This column reports taxable payments made to the named executives to cover premiums for universal life insurance policies owned by the executives. These policies include: (1) E (2) Leadership Life, which provides universal life insurance policies for the named executives with coverage of two times their salary plus 100 percent of their latest bonus payment d This column reports company matching contributions to the named executives’ 401(k) savings accounts of 3.5 percent of pay up to the limitations imposed under IRS rules.

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Name of Executive

Other Bene�itsa

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11fn2)

($)

Tax Paymentsb

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11

($)

Sherin 178,522 14,403

Neal 185,253 0

Rice 130,547 12,915

Denniston 74,943 21,000

Nissen 34,695 4,923

Wright 1,274,024 13,195

a See the 2008 Other Bene�its Table for additional information. b This column reports amounts reimbursed for the payment of taxes with respect to �inancial counseling, tax preparation services, and the personal use of car service. Starting in 20 services. c This column reports taxable payments made to the named executives to cover premiums for universal life insurance policies owned by the executives. These policies include: (1) E (2) Leadership Life, which provides universal life insurance policies for the named executives with coverage of two times their salary plus 100 percent of their latest bonus payment d This column reports company matching contributions to the named executives’ 401(k) savings accounts of 3.5 percent of pay up to the limitations imposed under IRS rules.

The following table describes other bene�its and the cost to the company of providing them. The total amount of these other bene�its is included in the All Other Compensation Table for each named executive.

2008 Other Bene�its

The following table describes other bene�its and the incremental cost to the company of providing them in 2008. The total amount of these other bene�its is included in the 2008 All Other Compensation Table above for each named executive.

Name of Executive

Use of Aircrafta

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11fn6)

($)

Leased Carsb

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#ch11

($)

Immelt 189,449 0

Sherin 116,673 31,170

Neal 175,060 0

Rice 69,484 18,534

Denniston 9,713 28,620

Nissen 0 21,040

Wright 244,083 8,832 a The calculation of incremental cost for personal use of company aircraft includes the variable costs incurred as a result of personal �light activity: a portion of ongoing maintenanc scheduled inspections, which would have been incurred regardless of whether there was any personal use of the aircraft. b Includes expenses associated with the leased cars program, such as leasing and management fees, administrative costs, and gas allowance. c Includes expenses associated with the use of advisors for �inancial, estate, and tax preparation and planning, as well as investment analysis and advice. d This column reports the total amount of other bene�its provided, none of which individually exceeded the greater of $25,000 or 10 percent of the total amount of these bene�its for events at board meetings for the executives’ spouses, (4) participation in the Executive Products and Lighting Program pursuant to which executives can receive GE appliances or ot contributions aggregating $1 million made by the company to charitable organizations upon Mr. Wright’s retirement as a director.

Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)

President Barack Obama signed the Wall Street Reform and Consumer Protection Act of 2010 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss472) to further enhance the transparency of executive compensation practices. Also commonly referred to as the Dodd-Frank Act (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss114) , the act requires the companies that trade stock on public exchanges to comply with four major provisions. The �irst provision requires say on pay (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/bm01#bm01goss393) . Say on pay gives company shareholders the right to vote yes or no on executive compensation proposals that are contained in proxy statements, including current and deferred components and golden parachute agreements. The frequency is determined by shareholder vote. Although the say on pay provision guarantees shareholders the right to vote on executive compensation proposals, the vote is nonbinding. That is, the outcome of shareholders’ voting does not overrule any compensation decision made by the company’s board of directors. The nonbinding vote advises the company’s board of directors of possible concerns about the structure of executive compensation packages, including excessive perks and the lack of clarity between compensation and business results. In 2013, shareholder support for executive compensation programs exceeded 90 percent, and only 2 percent of companies failed the vote based on receiving fewer than 50 percent support.31

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end31)

The second provision details independence requirements for compensation committee members and their advisors, such as compensation consultants and legal counsel. Members of compensation committees typically receive compensation for their services, and this practice is considered to be acceptable. However, possible violations of the Dodd-Frank independence requirement may arise when at least one committee member also receives compensation as a company employee. For example, a compensation committee member who also serves as the company’s executive vice president may be considered violating the independence requirement. On the other hand, a compensation committee member who does not receive compensation from the company as an employee or external consultant would not violate the independence requirement.

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Similarly, the Dodd-Frank Act speci�ies independence requirements for advisors to the compensation committee such as compensation consultants and legal counsel. A company’s compensation committee must consider whether the fees charged by advisors exceed reasonable limits based on the amount of the fees as a percentage of the company’s total revenue. Another consideration is whether an advisor has a business or personal relationship with committee members.

The third provision requires that companies disclose the circumstances under which an executive would bene�it from a golden parachute arrangement. Speci�ically, disclosure is required of all agreements and understandings that the acquiring and target companies have with the executive of�icers of both companies.

The fourth provision requires that companies report the ratio of CEO compensation to the median compensation of its employees in SEC �ilings that require executive compensation disclosure. This disclosure will help inform shareholders when taking a “say on pay” vote. The SEC adopted this rule in August 2015, with which companies must comply for their �irst �iscal year beginning on or after January 1, 2017. The rule provides companies with �lexibility in calculating this pay ratio. For instance, a company may choose the methodology for identifying its median employee and that employee’s compensation. Statistical sampling of its employee population is considered to be an acceptable method.

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11.6 EXECUTIVE COMPENSATION: ARE U.S. EXECUTIVES PAID TOO MUCH?

11-6 Brie�ly explain the executive compensation controversy as it relates to whether U.S. executives are paid too much.

Are U.S. executives paid too much? Popular press and newspaper accounts generally suggest that executives are overpaid. Of course, you should form your own opinion based on the following pertinent information:

Comparison between executive compensation and other worker groups

Strategic questions: Is pay for performance?

Ethical considerations: Is executive compensation fair?

International competitiveness

Comparison between Executive Compensation and Compensation for Other Worker Groups

The median annual earnings for all civilian workers was $47,230 in May 2014.32

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end32) Among the nonexecutive employees, fast food cooks earned the least ($19,480) and anesthesiologists earned the most ($246,320).33 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end33) The U.S. Bureau of Labor Statistics reports that the median annual salary for top executives was $180,200.34

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end34) However, other surveys provide substantially higher estimates. For example, the Wall Street Journal/Hay Group survey reports that average annual total compensation amounts to approximately $11.4 million, of which $1.2 million is annual salary, $2.3 is annual incentives, and $7.9 million is based on long-term incentives. The difference in reported amounts for CEO pay is staggering, but closer consideration of sample characteristics helps to explain some of this gap. The U.S. Bureau of Labor Statistics conducts a nationwide survey of a representative sample of companies in the private and public sectors, by different ownership types, and company size. The Wall Street Journal/Hay Group study is based on the 300 largest �irms based on an analysis of proxy statements �iled with the SEC.35

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end35)

Strategic Questions: Is Pay for Performance?

There are several measures of corporate performance (Table 11-5 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec6#ch11tab05) ). Are CEOs compensated commensurately with their companies’ performance? It is dif�icult to answer just yes or no because the evidence is mixed based on decades of academic research and the compensation of executives relative to company performance; therefore, a simple statement cannot be made about the relationship between CEO pay and company performance. Shareholder returns most often describe company performance, but there are complex forces beyond the control of CEOs that may in�luence shareholder returns. For example, in the pharmaceutical industry, substantial investments in research to identify promising medicines require trial and error before a promising outcome occurs in the laboratory. Then lengthy clinical trials that span multiple years may show that the new medication does not cure an illness for which it was created. Such public failures often result in lower con�idence in the company, which often translates into lower shareholder returns. In the intervening time, the company hires a new CEO who was not involved in the decision to pursue the failed initiative, raising the question whether she should receive lower compensation following a decline in shareholder returns.

TABLE 11-5 Corporate Performance Measures

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Size

Sales

Assets

Pro�its

Market value

Number of employees

Growth Sales

Assets

Pro�its

Market value

Number of employees

Pro�itability

Pro�it margin

Return on assets (ROA)

Return on equity (ROE)

Capital Markets Dividend yield

Total return to shareholders

Price–earnings ratio

Payout

Liquidity Current ratio

Quick ratio

Working capital from operations

Cash �low from operations

Leverage

Debt-to-equity ratio

Short-term vs. long-term debt

Cash �low vs. interest payments

Nevertheless, some companies do reduce CEO pay when company performance does not meet a preestablished standard. For example, Credit Suisse cut its CEO’s incentive pay in 2014 by more than 1 million Swiss francs when the company reported a 19 percent decline in pro�its because of costly legal battles in which the company has been involved.36 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end36) Canadian aircraft manufacturer Bombardier cut its former CEO’s pay drastically in 2014 from $6.02 million the year before to $5.16 million when the company failed to meet its deadline for a new product launch.37 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end37)

Ethical Considerations: Is Executive Compensation Fair?

Is executive compensation fair? Three considerations drive this question: companies’ abilities to attract and retain top executives, income disparities between executives and other employees, and layoffs of thousands of nonexecutive employees.

ATTRACT AND RETAIN TOP EXECUTIVES

Many compensation professionals and board of directors members argue that the trends in executive compensation are absolutely necessary for attracting and retaining top executives. Even though most CEOs are promoted from within, it is often the case that companies that hire new CEOs from other companies pay them substantially more than individuals who are promoted to CEO from within the company ranks. For example, median total pay for internal promotions was $7.76 million while nearly 42 percent higher for external hires, amounting to $10.99 million.38

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end38) However, regardless of source, the typical percentage of total compensation awarded in equity plans was approximately 50 percent.

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INCOME DISPARITIES

Table 11-6 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec6#ch11tab06) illustrates the marked income disparity between annual pay for various nonexecutive jobs and pay for CEOs. The typical annual earnings for the lowest-paid occupation (fast food cooks) amounted to a mere 0.55 percent (yes, about one-half of 1 percent) of the average annual CEO salary and bonus. The ratio of highest-paid occupation (anesthesiologiests) to the average annual CEO salary and bonus was not much better (i.e., 7.0 percent). Said differently, the typical CEO’s annual salary plus bonus was nearly 180 times greater than the typical fast food cook’s annual pay and approximately 15 times greater than the typical anesthesiologist’s annual pay!

TABLE 11-6 Selected Median Annual Nonexecutive Earnings, May 2014

Occupation Annual Earnings ($)

Anesthesiologists 246,320

Lawyers 133,470

General and operations managers 117,200

Registered nurses 69,700

Construction and equipment operators 47,340

Of�ice clerks 30,820

Teacher assistants 26,000

Fast-food cooks 19,480 Source: U.S. Bureau of Labor Statistics. (2015). Occupational Employment Wages—May 2014 (USDL: 15-0479). Available: www.bls.gov (http://www.bls.gov) , accessed April 7, 2015.

Labor unions continually argue that substantial pay discrepancies between CEOs and non-CEOs are socially unjust and promote economic inequality. The AFL- CIO indicates that the CEO-to-minimum wage pay ratio was 774:1.39 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end39) In addition, they maintain that the full-time minimum wage earners would work 1,372 hours to earn one hour of former CEO Michael Duke’s (Walmart) pay.

LAYOFFS BORNE BY WORKERS BUT NOT EXECUTIVES

Millions of workers have been laid off since 1990. Between late 2008 and mid-2009 alone, more than 2 million employees lost their jobs.40

(http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end40) Top management typically advances several reasons that necessitate these layoffs (e.g., global competition, reductions in product demand, technological advances that perform many jobs more ef�iciently than employees, mergers and acquisitions, establishing production operations in foreign countries with lower labor costs, and the steep economic downturn following the recession). A scant few executives lost their jobs, but millions of workers lost theirs in the years following the start of the 2008 economic recession.

International Competitiveness

Increased global competition has forced companies in the United States to become more productive. Excessive expenditures on compensation can threaten competitive advantage. Compensation expenditures are excessive when they outpace the quality and quantity of employees’ contributions. In addition, compensation expenditures may be excessive when they are substantially higher than competitors’ compensation outlays. Concerns about U.S. companies’ competitiveness in global markets are common because of the vast differences in compensation levels between the CEOs of U.S. and foreign companies.

INTERNATIONAL COMPENSATION COMPARISONS

The SEC rules require the disclosure of executive compensation in U.S. companies; however, comparable rules do not exist in many foreign countries. As a result, it is dif�icult to make detailed comparisons between U.S. and foreign executive compensation. Nevertheless, recent research has studied the levels and composition of CEO compensation in the U.S. and in other countries where disclosure laws necessitate reporting of CEO pay. Prior to and since this scienti�ic study, surveys indicated that U.S. CEOs make upwards of 300 percent more than their counterparts in other countries. However, while this study demonstrates that CEOs make more than their counterparts, the gap is far more modest. Speci�ically, the average pay premium was only 26 percent after controlling for relevant characteristics such as company size, ownership and board of directors structure, and CEO characteristics such as source of CEO (internal or external hire), age, and past industry experience.41 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec11#ch11end41) This study found that non-U.S. CEOs earned an annual median total compensation of $1.6 million and U.S. CEOs earned $3.3 million. The levels varied tremendously among non-U.S. CEOs, ranging from $0.9 million in Belgium to $2.7 million in Italy. Composition also varied. For instance, the typical Canadian CEO earned only 33 percent of total compensation in salary while the typical Swedish CEO earned 62 percent of total compensation in salary.

UNDERMINING U.S. COMPANIES’ ABILITY TO COMPETE

At present, there is no evidence showing that U.S. executive compensation pay practices have undermined U.S. companies’ ability to compete with other companies in the global marketplace. Might executive compensation practices undermine U.S. companies’ competitiveness in the future?

On one hand, it is reasonable to predict that CEO pay will not undermine U.S. companies’ ability to compete because CEO pay increased as company pro�its increased. On the other hand, the current wave of widespread layoffs may hinder U.S. companies’ competitiveness. The U.S. companies use layoffs to maintain pro�its and cut costs, heightening workers’ job insecurities. The remaining workers may lose their faith in pay-for-performance systems and their trust in their employers as colleagues lose their jobs and CEOs continue to receive higher compensation. Workers may not feel that working hard will lead to higher pay or job security; therefore, they may choose not to work pro�iciently. As a result, reduced individual performance and destabilized workforces may make it dif�icult for U.S. companies to compete against foreign companies.

COMPENSATION IN ACTION

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Executive compensation, long under the watchful eye of the public and politicians, has been under a microscopic lens during the recent global economic crisis. Executive compensation decisions are approved in the end by the board of directors (in response to recommendations provided to them by the compensation committee of the board and external executive compensation consultants); however, line managers and HR should seek to understand the principles being applied and the compensation plans being employed. This knowledge will help as employees raise questions about executive compensation, and it will make you more aware of practices that are fair and successful versus practices that are blatantly contrary to law, thus being able to protect the company and its employees. Perhaps if line managers and HR managers had been more vigilant about these processes, the tragedies at Enron and Tyco would never have occurred.

Action checklist for line managers and HR—assessing executive compensation in your company

HR takes the lead

Conduct an analysis of the company’s culture, ideals, values, and history. Does the executive compensation plan align with those factors?

Is the executive compensation plan balanced with regards to cash versus equity, reward versus risk, short-term versus long-term performance? An overemphasis on any one side could result in behaviors that help executives but hurt the shareholders and the company in the end.

What severance plans are being offered? Do the platinum parachutes in your company essentially minimize all risks for executives? Will the �inancial windfall be so large that an executive has little reason to avoid failure?

If you believe the practices of your organizations are not in accordance with the disclosure regulations of the SEC or the requirements outlined explicitly under the Sarbanes-Oxley Act, it may be necessary for you to bring this to the attention of line managers. Together you can take these concerns to the proper people inside or outside the company.

Line managers take the lead

What are the objectives by which the executives in your company are being measured? Are these similar to the objectives by which you are measured?

What are the long-term incentives? Is this completely tied to stock price? Ideally, the long-term plan should include multiyear stock and a cash plan. With the plan too tied to stock price (through stock options), the wrong behaviors are encouraged and shareholders suffer in the long term. (Note: At the start of 2000, 90 percent of long-term incentives were in the form of stock options; now it is closer to 50 percent.)

END OF CHAPTER REVIEW

MyManagementLab Go to mymanagementlab.com (http://mymanagementlab.com) to complete the problems marked with this icon .

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Summary

Learning Objective 1: Executive compensation is determined by a company’s board of directors who are usually high-level executives, either within and outside the company, as well as prominent community members, such as lawyers. The recommendation for executive compensation comes from a compensation consultant, who is often hired by the CEO. Compensation for nonexecutive employees is typically based on market rates or from the negotiations between union and management, and is adjusted according to performance or acquisition of new knowledge or skills.

Learning Objective 2: The Internal Revenue Code de�ines two group of employees—key employees and highly compensated employees—who are deemed to have executive status. Although the criteria differ somewhat between these two groups, both criteria are generally based on salary level and ownership stake in the company.

Learning Objective 3: The components of executive compensation packages include four main components: (1) current or annual core compensation, various types of deferred compensation, including (2) stock-based compensation, and (3) separation agreements such as golden parachutes and platinum parachutes, (4) enhanced employee bene�its and perquisites, and (5) clawback provisions.

Learning Objective 4: The principles and processes for setting executive compensation are based on three theories. These include agency theory, tournament theory, and social comparison theory.

Learning Objective 5: Executive compensation disclosure rules were established to protect the interests of potential and current investors (or, shareholders) of companies. Both the Securities and Exchange Act of 1934 and the Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) require extensive reporting of executive compensation amounts and the rationale for these amounts for the CEO and named executive offers, and shareholder engagement through nonbinding votes on proposed executive compensation packages.

Learning Objective 6: There is ongoing public controversy regarding whether executives are excessively highly compensated. The debate draws on various data and principles, such as international competitiveness, fairness, and social justice. There is not a straightforward solution to this controversy based on differences in data presented to support each side’s arguments as well as differences in ideology.

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Key Terms key employee (253 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec1#page_253) ) highly compensated employee (255 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec2#page_255) ) discretionary bonuses (256 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_256) ) performance-contingent bonuses (256 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_256) ) predetermined allocation bonus (256 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_256) ) target plan bonus (256 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_256) ) equity plans (257 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_257) ) separation agreements (257 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_257) ) deferred compensation (257 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_257) ) company stock (257 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_257) ) company stock shares (257 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_257) ) incentive stock options (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) capital gains (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) capital loss (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) nonstatutory stock options (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) restricted stock plans (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) restricted stock units (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) performance plan (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) stock appreciation rights (258 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_258) ) phantom stock (259 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_259) ) offering period (259 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_259) ) golden parachutes (259 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_259) ) platinum parachutes (260 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_260) ) clawback provisions (260 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_260) ) Sarbanes-Oxley Act of 2002 (260 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_260) ) perquisites (260 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_260) ) perks (260 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_260) ) supplemental life insurance (261 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_261) ) supplemental retirement plans (261 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_261) ) executive compensation consultants (262 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec3#page_262) ) board of directors (263 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_263) ) compensation committee (264 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_264) ) agency theory (264 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_264) ) agency problem (264 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_264) ) tournament theory (265 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_265) ) social comparison theory (265 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_265) ) Securities and Exchange Commission (SEC) (266 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_266) ) Securities Exchange Act of 1934 (266 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_266) ) De�initive Proxy Statement [DEF 14(A)] (266 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_266) ) Named Executive Of�icers (NEO) (266 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_266) ) Compensation Discussion and Analysis (CD&A) (266 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec4#page_266) ) Wall Street Reform and Consumer Protection Act of 2010 (269 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#page_269) ) Dodd-Frank Act (269 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#page_269) ) say on pay (269 (http://content.thuzelearning.com/books/Martocchio.7916.16.1/sections/ch11lev1sec5#page_269) )

MyManagementLab CHAPTER QUIZ! If your professor has assigned this, go to the Assignments section of mymanagementlab.com (http://mymanagementlab.com) complete to the Chapter Quiz! and see what you’ve learned.

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Discussion Questions 11-1. What can be done to make the function of compensation committees consistent with shareholders’ interests? Explain your answer.

11-2. Which component of compensation is most essential to motivate executives to lead companies toward competitive advantage? Discuss your rationale.

11-3. Discuss your position on executive compensation. Is executive compensation universally excessive or appropriate?

11-4. Discuss the differences between enhanced bene�its and perquisites. 11-5. Consult a recent news article about a company’s executive pay. Summarize the main issues detailed within the article.

CASE CEO Pay in the News

An additional Supplemental Case can be found on MyManagementLab.

A recent campaign by organized labor unions has brought the issue of executive compensation into the public eye. Media coverage of executive compensation concerns has been extensive over the past few weeks with articles in national publications and a featured story on a television special, in addition to stories on local news stations. This extensive coverage has highlighted public concerns of the high level of pay that top executives receive. The union promotes an executive compensation awareness campaign every year as a strategy to build awareness of perceived inequities between the pay of CEOs and frontline employees. Such awareness often prompts employees to consider forming a union, resulting in the growth of national unions.

The publicity has caused some turmoil at Oakwood Lawns. For the �irst time, the company’s CEO pay is featured as an example of perceived excess in the executive suite. Several �ield managers have been in touch with Don Henry, the director of human resources, to report that employees are outraged at the rate of pay of the company CEO and other top executives. In addition to the company’s desire to remain union-free, Don also knows that such outrage could lead to low morale and other problems at Oakwood.

The union targeted Oakwood because it is a big company that has faced some �inancial challenges. The landscaping company has more than 15,000 employees in of�ices throughout the Midwest, and most of its employees are frontline laborers. The media coverage has been extensive in the area, and many company employees who viewed the story were surprised to learn the CEO is among the highest paid in the United States. The news was especially dif�icult to hear as the company recently announced that employees would not receive an annual pay increase due to the �inancial challenges the company is facing.

Oakwood CEO’s annual salary is $975,000. Add in a bonus, stock awards, retirement bene�its, and other bene�its, and his total compensation is close to $10 million a year. The average landscaping technician is paid $28,000 annually. The disparity is clear, and Don must now plan a response to address the employees’ concerns.

Questions:

11-6. What additional information about the CEO’s pay package should Don identify to potentially share with the employees? 11-7. How can Don explain the pay disparity to the employees to ease their concerns about the fairness of the CEO’s pay?

Crunch the Numbers! Comparison of Pay within and Across Industries

An additional Crunch the Numbers! exercise can be found on mymanagementlab.com (http://mymanagementlab.com) .

As a newly hired compensation analyst, you have been asked to conduct analyses to determine differences in pay for similar jobs between two industries, the ratio of pay for similar jobs within two industries, and the ratio of pay for different jobs within an industry. The data represent annual base wages and exclude incentives or employee bene�its. These data were extracted from the U.S. Bureau of Labor Statistics Occupational Employment Statistics Query System (www.bls.gov (http://www.bls.gov) ) for May, 2014.

Industry

Oil and Gas Extraction Retail

Occupation Annual median wage ($) Annual median wage ($)

Chief Executives 187,199 180,360

Human Resources Managers 118,730 95,020

Accountants and Auditors 71,780 64,920

File Clerks 30,700 23,430

Questions:

11-8. By what percent does annual median pay differ between the oil and gas extraction industry and the retail trade industry for (a) chief executives, (b) human resources managers, (c) accountants and auditors, and (d) �ile clerks?

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11-9. In the oil and gas extraction industry relative to the retail trade industry, what are the pay ratios between (a) chief executives, (b) human resources managers, (c) accountants and auditors, and (d) �ile clerks, respectively?

11-10. In the oil and gas extraction industry, what are the pay ratios for the chief executives job to (a) human resources managers, (b) accountants and auditors, and (c) �ile clerks? In the retail trade industry, what is the ratio of pay for chief executives to (d) human resources managers, (e) accountants and auditors, and (f) �ile clerks, respectively?

MyManagementLab Go to mymanagementlab.com (http://mymanagementlab.com) for Auto-graded writing questions as well as the following Assisted-graded writing questions:

11-11. Summarize three forms of deferred (stock) compensation.

11-12. What are the objectives of the say-on-pay rule? Do you think that shareholders should be limited to taking an advisory vote or should shareholders be able to determine an executive’s compensation?

11-13. MyManagementLab Only—comprehensive writing assignment for this chapter.

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Endnotes 1. Walters, B., Hardin, T., & Schick, J. (1995). Top executive compensation: Equity or excess? Implications for regaining American competitiveness. Journal of Business Ethics, 14, pp. 227–234.

2. Internal Revenue Code, §416 (i). 3. Treas. Reg. §1.416–1, Q13. 4. Internal Revenue Code, §414 (q). 5. §162(m) 6. Esterl, M., & Lublin, J. S. (2014). Coke scales back executive equity compensation, bowing to pressure. The Wall Street Journal (October 1). Available: www.wsj.com (http://www.wsj.com) , accessed February 15, 2015.

7. Internal Revenue Code 61, 83, 162, 451; Treasury Regulations 1.83. 8. Internal Revenue Code 61, 83, 162; Treasury Regulations 1.83. 9. Joshi, P. (2013). Golden parachutes are still very much in style. The New York Times (June 29). Available: www.nytimes.com (http://www.nytimes.com) , accessed March 31, 2015.

10. Reindl, J. C. (2014). Compuware execs could get millions in golden parachutes. The Detroit Free Press (November 7). Available: www.freep.com (http://www.freep.com) , accessed April 4, 2015.

11. Mann, T. (2015). A $195 million exit for United Technologies CEO. The Wall Street Journal (February 5). Available: www.wsj.com (http://www.wsj.com) , accessed February 10, 2015.

12. Wagner, D. (2014). Phoenix VA chief’s bonus rescinded among controversy. The Arizona Republic (May 22). Available: www.azcentral.com (http://www.azcentral.com) , accessed April 7, 2015.

13. Martocchio, J. J. (2011). Employee Bene�its: A Primer for Human Resource Professionals. Burr Ridge, IL: McGraw-Hill. 14. I.R.C. §415 (b)(1)(A). 15. Holloway, S. (2015). Executive Perquisites. Workspan (March). Available: www.worldatwork.org (http://www.worldatwork.org) , accessed April 7, 2015. 16. Hodgson, P. (2015). Come �ly with them: These CEOs spend the most on the corporate jet. Fortune (January 27). Available: www.fortune.com

(http://www.fortune.com) , accessed March 5, 2015. 17. Zillman, C. (2015). Which Fortune 100 CEO has the biggest security budget? Fortune (January 7). Available: www.fortune.com (http://www.fortune.com) ,

accessed April 2, 2015. 18. Walker, J. (2015). Fore! Regeneron CEO must pay for his own golf club membership. The Wall Street Journal (March 20). Available: www.wsj.com

(http://www.wsj.com) , accessed March 22, 2015. 19. Ahmed, M. (2013). Despite the scrutiny, perks remain a key component of executive rewards. Executive Compensation Bulletin (July 31). Available:

www.towerswatson.com (http://www.towerswatson.com) , accessed April 3, 2015. 20. Crystal, G. S. (1991). Why CEO compensation is so high. California Management Review, 34, pp. 9–29. 21. Ibid. 22. Ibid. 23. Eisenhardt, K. M. (1989). Agency theory: An assessment and review. Academy of Management Review, 14, pp. 57–74; Jensen, M., & Meckling, W. H. (1976).

Theory of the �irm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics, 3, pp. 305–360; Tosi, H. L., Jr., & Gomez- Mejia, L. R. (1989). The decoupling of CEO pay and performance: An agency theory perspective. Administrative Science Quarterly, 34, pp. 169–189; Goodman, P. S. (1974). An examination of referents used in the evaluation of pay. Organizational Behavior and Human Performance, 12, pp. 170–195; Lazear, E., & Rosen, S. (1981). Rank-order tournaments as optimum labor contracts. Journal of Political Economy, 89, pp. 841–864; O’Reilly, C. A., III, Main, B. G., & Crystal, G. S. (1988). CEO compensation as tournament and social comparison: A tale of two theories. Administrative Science Quarterly, 33, pp. 257–274.

24. Jensen, M. C., & Meckling, W. H. (1976). Theory of the �irm: Managerial behavior, agency costs, and ownership structure. Journal of Financial Economics, 3, pp. 305–360.

25. Lazear, E., & Rosen, S. (1981). Rank-order tournaments as optimum labor contracts. Journal of Political Economy, 89, pp. 841–864. 26. Festinger, L. (1954). A theory of social comparison processes. Human Relations, 7, pp. 117–140. 27. Tversky, A., & Kahneman, D. (1974). Judgment and uncertainty: Heuristics and biases. Science, 185, pp. 1124–1131. 28. O’Reilly, C. A., III, Main, B. G., & Crystal, G. S. (1988). CEO compensation as tournament and social comparison: A tale of two theories. Administrative Science

Quarterly, 33, pp. 257–274. 29. Stynes, T. (2015). Polycom Inc. agrees to pay $750,000 to settle SEC civil charges. The Wall Street Journal (March 31). Available: www.wsj.com

(http://www.wsj.com) , accessed April 1, 2015. 30. Summary Compensation Table: 17 C.F.R 229.402(b), as amended November 29, 1993, effective January 1, 1994. 31. Slutsky, S. (2014). Say on pay: The shareholder’s voice emerges. Workspan (April): pp. 21–25. 32. U.S. Bureau of Labor Statistics. (2015). Occupational Employment Wages—May 2014 (USDL: 15-0479). Available: www.bls.gov (http://www.bls.gov) , accessed

April 7, 2015. 33. Ibid. 34. Ibid. 35. Hay Group. The Wall Street Journal/Hay Group CEO compensation survey 2013 (news release). Available: www.haygroup.com (http://www.haygroup.com) ,

accessed April 7, 2015. 36. Letzing, J. (2015). Credit Suisse cuts CEO Brady Dougan’s pay. The Wall Street Journal (March 20). Available: www.wsj.com (http://www.wsj.com) , accessed

April 1, 2015. 37. Vieira, P. (2015). Bombardier cut former CEO Beaudoin’s pay. The Wall Street Journal (March 31). Available: http://www.wsj.com (http://www.wsj.com) ,

accessed April 2, 2015.

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38. Equilar, Inc. (2015). In With the New – Compensation of Newly Hired Chief Executive Of�icers (February 7). Available: www.equilar.com (http://www.equilar.com) , accessed March 30, 2015.

39. AFL-CIO (2014). Executive Paywatch: High Paid CEOs and the Low Wage Economy. Available: www.a�lcio.org (http://www.a�lcio.org) , accessed April 1, 2015. 40. U.S. Bureau of Labor Statistics, Mass Layoffs; U.S. Bureau of Labor Statistics, Extended Mass Layoffs. 41. Fernandes, N., Ferreira, M., Matos, P., & Murphy, K. (2013). Are U.S. CEOs paid more? New international evidence. Review of Financial Statistics, 26: pp. 323–

367.