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Executive Compensation and special group compensation
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- 2. Learning objectives 1. Describea compensation strategy for each of the special groups discussed. 2. Discuss the issue of executive pay and explanations of why executive pay may be justified. 3. Discuss the importance of maintaining equity in the compensation of special groups. 4. Discuss what has changed in the way organizations function to make contingent workers increasingly important.
- 3. Components of ExecutiveCompensation Components of executive compensation can be studied in three perspectives, i.e., variable pay (e.g., bonuses, commissions, profit sharing, etc.), base pay (e.g., salary and perquisites), and employment status (e.g., promotions and termination). Distinction in these perspectives focuses on the uncertainty of present and future wealth, and emanate from agency discussions of risk bearing. Effective executive compensation packages typically comprise the following components: • Base Salary • Annual Incentives • Long-Term Capital Accumulation • Deferred Compensation Arrangements • Supplemental Benefits and Perquisites • Special Severance and Retirement Arrangements • Employment and Change of Control Agreements
- 4. Different Theories ofExecutive Compensation Executive compensation need to be designed innovatively primarily with three core components; cash (salary and bonus), various perquisites and supplementary benefits, and finally various long-term incentives. Tournament Theory – As per this theory, compensation is viewed as the prize in a series of tournaments or contests among middle and top-level managers, who aspire to become CEO. Winners of the tournament at one level enter the next tournament. In other words, an executive’s promotion to a higher rank signifies a win, and more lucrative compensation represents the prize. Social Comparison Theory – This theory suggests designing of compensation by comparing with similar individuals.
- 5. Balance Sheet Approach– This approach provides expatriates the standard of living they normally enjoy in their own country. Headquarters based pay – Compensation to all according to the rate used at the headquarters. Golden handcuffs – Compensation components earned over a period of time that assist in retaining an employee. Many organizations practice this approach to avoid attrition. Competency based pay – Pay related directly to the kinds and levels of competencies required in the performance of the work/job. Golden parachutes – Provide pay and benefits to executives after their termination resulting from a change in ownership, or corporate takeover. This is particularly for very senior level executives, who may dictate this condition in their terms of employment to protect their interests in the event of take over. DIFFERENT THEORIES OF EXECUTIVE COMPENSATION
- 6. Cafeteria plan –For executives, options for different nature of benefits, is commonly termed as cafeteria plan. Executives may select either of the alternatives as compensation benefit. Profit sharing plan – It provides direct or indirect payments, based on organization’s profitability, apart from regular compensation. Although employee stock options fit here as a good example, more applicable fit is Tata Group’s EVA plan. DIFFERENT THEORIES OF EXECUTIVE COMPENSATION
- 7. Executive compensation designprocess link compensation criteria (e.g., organizational performance or size) to compensation consequences (e.g., pay at risk). Such process or mechanism is categorised into two forms; process that centers on contract and the process that involves direct monitoring of the executive. Executive Compensation Design Process
- 8. Use of PerformanceCriteria for Designing Executive Compensation Use of performance criteria to design executive compensation, account for measurable performance targets, behaviour, job requirements, and experience of the executives, job role, peer compensation, market considerations and the size of the organization.
- 9. Context of ExecutiveCompensation Design Executive compensation design has its multifaceted effects on the firm's strategy, industry, and on the culture in which it operates. Such multifaceted dimension of effects, require us to examine executive compensation from different contexts. The decision context encompasses the individual choices of executives. The strategic context examines organizational goals, and suggest on matching resources to goal achievement. Environmental and cultural factors examine industry characteristics, national and global economic, cultural, and political factors. Influence of contextual factors on the executives’ decision on compensation in a globalised world, has now started gaining importance. Cultural factors examine effect of compensation strategy across many countries. This aspect is more important for multi-nationals and transnational, who operate globally.
- 10. Decision Context Compensation designin the decisional context considers framing of problems of a decision maker, and is part of behavioural economics. Executive compensation decision considers utility or preference theory of decision making. An individual employee may be risk aversive at one point of time and gambler at another point of time more or less on same decisional issues. In compensation context, an individual employee may prefer opting for a job in large organization with stringent targets over a more stable with decent compensation job in small organizations.
- 11. Culture and ExecutiveCompensation Culture of an organization evolves over time and is influenced by several factors. It is moulded by unusual business conditions. Organizational culture influence managerial practices, and so also the compensation practices. Calibration of Executive compensation to performance The concept of calibrating pay to performance is the 'Market value measure'. The key to the model is ensuring the measures being selected are pertinent, so that the right set of behaviours are being encouraged. To simply say that a particular executive is a high performer may not only be a sweeping generalisation, it may also be in reference to measures that are not currently important to the organization.
- 12. Pay Calibration High Pay/ LowPerformance High Pay/High Performance Low Pay/Low Performance Low Pay/High Performance
- 13. Performance measurement inexecutive incentive programmes Linking executive compensation to organizational performance, shareholders’ value creation has become extremely important. Effective performance measures ensure that executive compensation is commensurate with performance. Points for consideration are: • Alignment with shareholders’ interests • Definable • Measurable • Controllable • Easily communicated and understood Assessing potential performance objectives against these criteria can help to ensure the appropriateness of the measure or measures ultimately used.
- 14. Relating Executive Compensationto organizational strategy Organizations need to design executive compensation to reward the work, which by default can realise the organizational strategy. Designing executive compensation in the era or economic uncertainty, rationalizing both the expectations of the executives and organizational strategic intent, is the most challenging task. It requires optimisation of the cost of compensation, rationalisation of compensation budget restructuring the deferral components of compensation, optimisation of the cost of retirement benefits, using funded pension assets through stock build-up.
- 15. Who Are SpecialGroups? Supervisors Corporate Directors Chief Executive Officers and Top Management Professional Employees Sales Staff Contingent Workers Dot-com Employees
- 16. Supervisor Pay The majorchallenge in compensating supervisors centers on equity. Some incentive must be provided to entice nonexempt employees to accept the challenges of being a supervisor. One approach is to key base salaries of supervisors to some amount exceeding the highest paid person in the unit.
- 17. Supervisor Pay (continued) Anotherapproach is to pay supervisors for scheduled overtime. Develop special supervisory incentive and bonus plans: annual bonus spot award lump sum individual incentive
- 18. Conflicts Faced ByCorporate Directors Help set strategic plans that affect profits. Face the possibility that disgruntled stockholders may sue over corporate strategies that are unprofitable or unpopular
- 19. Direct Compensation toCorporate Directors Annual retainer Attendance fees Fees for participation on subcommittees Increasing emphasis on director rewards that link to corporate performance More pay is stock-based
- 20. Major Benefits Offeredto Directors Retirement programs Matching director’s gift to college or university Deferral of cash compensation until retirement Grants to charity Medical insurance Payment of spouses travel expenses Death benefits
- 21. Conflicts Faced ByTop Management Stockholders want healthy returns on investment. Government wants compliance with laws. Must decide between strategies that maximize short- term gains versus directions that focus on the long run.
- 22. Components of anExecutive Compensation Package Base salary Short-term (annual) incentives or bonuses Long-term incentives and capital appreciation plans Executive benefits Executive perquisites
- 23. Examples of Long-TermIncentives for Executives Incentive stock options Non-qualified stock options Phantom stock plans Stock appreciation rights Restricted stock plans Performance share / unit plans
- 24. Examples of PopularPerquisites Offered to Executives Physical Exam Company Car Financial Counseling Company Plane Income Tax Preparation First-Class Air Travel Country Club Membership Luncheon Club Membership Estate Planning Personal Liability Insurance Spouse Travel Chauffeur Service Reserved Parking Executive Dining Room Home Security System Car Phone Financial Seminars Loans at Low or No Interest Legal Counseling
- 25. Conflicts Faced ByProfessional Employees May be torn between the goals, objectives, and ethical standards of their profession and the demands of an employer concerned more with the profit motive.
- 26. Pay Components forProfessional Employees Dual career ladders Knowledge-based bonuses Advanced and continuing education Professional licenses and certification Bonuses Royalty compensation Intellectual property rights
- 27. IBM Dual Ladders SeniorAssociate Associate Engineers, Programmers, Scientists MANAGEMENT LADDER TECHNICAL LADDER Project Development Senior Functional Management Executives Staff Advisory Senior Senior Technical Staff Member IBM Fellow
- 28. Conflicts Faced BySales Staff Often go for extended periods in the field with little supervision. Challenge is to stay motivated and continue making sales calls despite little supervision
- 29. Key Factors inDesigning a Sales Compensation Plan The nature of the people who enter the sales profession Organizational strategy Competitor practices Product sold
- 30. Alternative Sales PayPlans Guaranteed base salary Guaranteed base salary + commission Guaranteed base salary + bonus Guaranteed base salary + commission + bonus Commission only
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- 32. Key Steps inDesigning a Sales Compensation Plan Establish clear strategic objectives Establish tactical objectives Analyze organizational data Establish proper base pay rates Design appropriate commission formula Test the plan Control for windfalls
- 33. Contingent Workers Play animportant “safety valve” role for companies. When demand is high, more are hired. When demand drops, these are the first workers downsized. Employment status is highly insecure. Challenge is to find low cost ways to motivate.
- 34. Key Issues inContingent Workforce Compensation
- 35. Benefits Offered toContingent Workers
- 36. Compensating Dot-com Employees Specialgroup employees all have jobs with high potential for conflict. The resolution of this conflict is central to the goals of the organization. Because of these characteristics, special groups receive compensation treatment that differs from other employees.
- 37. Summary Governments around theworld play varying roles in the workplace. Legislation in any society reflects people’s expectations about the role of government. Beyond direct regulation, government affects compensation through policies and purchases that affect supply and demand for labor. In the United States, legislation reflects the changing nature of work and the workforce. 1930s legislation was concerned with the social safety net 1960s legislation turned to the issue of civil rights
- 38. Review Questions 1. Whathas changed about the way corporations function to make contingent workers increasingly important? 2. Why are firms moving to different types of long- term incentives for executives in a shift away from stock options? 3. Is it possible for occupational groups other than those discussed here to assume the status of a special group for the purposes of compensation. Explain why or why not. 4. Explain how the issue of equity is especially important for special group employees.