Motivating managers to have interests

Please choose a topic (as below) from the meetings, and prepare a 4-page write-up, where you collect articles you can find online, and discuss how they relate to each other and to the topic we discussed in class

Motivating CEOs:

Competitive compensation
• Motivating managers to have interests that are similar to those of
the shareholders:
• Base Salary
• Bonus and non-equity incentive plans
• Restricted Stocks
• Options
• Note: These are not the only mechanisms that are used to align
incentives:
• Managerial stock holdings in the company
• Reputation
• Career concerns

Main components of compensation
• Base salary
• Does not depend on performance.
• Determined using peer groups of firms with similar size and similar industries.
• Bonus and non-equity incentive plans
• Compensation which depends on performance – (not stock related).
• Measures that are used: EPS, Sales growth, EVA, ROA, ROE and others.
• Bonuses are usually based on annual performance while incentive plans are based on longer terms (usually 3 year performance).
• Restricted stocks
• Usually paid based on performance/tenure.
• Vesting period.
• Options
• Usually paid based on plans.
• Usually given at the money.
• Vesting period.

Pay for Performance – How should we
design the compensation package?
Some Considerations:
• Efficiency of Incentives
• Fragility of Incentives
• Incentives and appetite for risk – the case of options.
• Horizon – Short term or long term?
• Performance measure:
• Accounting-based vs. stock-based performance.
• Relative vs. absolute performance?

Pay for performance

Performance
Pay

Cost to Firm vs. Value to manager
• The value to the executive of equity pay (V) is generally lower than its
cost to the company’s shareholders (C).
• Factors that affect the discount:
• The degree of diversification in the executive’s holdings (greater diversification
increases V/C)
•  The risk aversion of the executive (greater risk aversion lowers V/C)
•  The volatility of the stock (higher volatility lowers V/C)
•  The vesting period of the equity (longer vesting lowers V/C
• For options: the extent to which the options are in the money (the further in
the money, the higher is the V/C).
Adrian Aycan Corum 10

Cost to Firm vs. Value to manager
• For stock grants: V/C generally on the order of 85%.
• For at-the-money stock option grants, V/C is between 80% and 40%.
• The discount is a “deadweight loss” to the company’s shareholders.
• Need to weigh the benefits of performance improvements from the
option-linked strengthening of retention and ownership incentives
against the added costs.