Professional Documents
Culture Documents
Executive Compensation
Overview
Review of
Efficient Contracting Theory
Agent-Principle Conflict
Managers, like investors, are rational
Act toward self-interest, risk-averse, effort-averse
Non-financial measures
Internal peer/executive evaluations; personal goals;
management initiatives; etc.
1) Components of Compensation
Salary
Short-term incentives
Cash
Or if elected, deferred share units
Provide flexibility to executives to convert short-term
incentives to mid-term incentives
Mid-term incentives
3-year deferred share units
Long-term incentives
10-year ESO, vesting at 25% per year for first 4 years
Must hold specific amount of shares (e.g. shares worth
8 times salary, for the president and CEO)
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Individual bonus
Overall bank and segment performance, relative to targets and
peer group
Non-financial performance measures (personal goals, etc.)
Mid-term
Share price performance over the previous 3 years,
relative to peer group
Conditioned on achievement of target ROE (20%)
Long-term
Set share price on the ESO award date (i.e. price at year
0) as exercise price
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etc.
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Sensitivity
The closer the measure to true manager
efforts, the more sensitive the measure is
Precision
The less noise contained in the measure, the
more precise the measure is
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Full disclosure
More difficult for manager to disguise shirking by
earnings management
Enables compensation committee to better
evaluate earnings persistence
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10.4.3 Controlling
Compensation Risk
Managers are rational
The more risk managers bear on a project, the higher
compensation they expect
Compensation risk
The risk that the compensation is more or less than
expected
Either way will result in lower manager effort
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10.6 Politics of
Executive Compensation
Is executive compensation too high?
If so, suggests inefficient contracting
Ignore extraordinary losses (Jensen & Murphy 1990)
Managers do not bear enough risk
Solution: have managers hold more stock
Golden parachutes
Excessive retirement package
Is Executive Compensation
Too High?
Counter evidence: Gayle & Miller 2009
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Say on pay
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10.9 Conclusions
Financial reporting plays two important roles in
motivating manager effort
Provides a performance measure input into
compensation contracts
helps compensation committees tie pay to
performance, control manager power, and increase
contract efficiency