Executive Compensation Plans Research Articles

Image, performance, attitudes, trust, and loyalty in financial services

PurposeThe purpose of this paper is twofold: first, to determine the extent to which hedonic and utilitarian attitudes and loyalty are influenced by perceived financial performance (PFP) and executive compensation plan image (ECPI) in financial services; second, the authors evaluate relationships among hedonic and utilitarian attitudes, trust, and loyalty.Design/methodology/approachUsing a quasi-experimental design in Study 1 the authors test the relationship between antecedents (PFP and ECPI) and relational elements (attitudes, trust, and loyalty) to address the first objective. To accomplish the second objective, the authors employ structural equation modeling in Study 2 to test the relationship among hedonic and utilitarian attitudes, trust, and loyalty.FindingsStudy 1 confirms that PFP and ECPI positively impact both hedonic and utilitarian attitudes but do not directly affect loyalty. Study 2 demonstrates a positive association between utilitarian attitudes and trust, although the hedonic attitudes-trust relationship is negative. Hedonic attitudes are also significantly related to utilitarian attitudes. Finally, trust mediates the relationship between attitudes and loyalty.Practical implicationsBuilding customer trust is an important correlate of loyalty, and emphasizing an attribute-based aspect of perceived financial service generates greater trust compared to enhancing a non-attribute aspect (i.e. minimizing negative effects on image of executive compensation plans).Originality/valueThe authors link attitude research to service/relationship quality research and discover that attitudes are indirectly related to loyalty through increases in trust. The findings suggest that perceived image and performance of financial services are important to relationship quality when applied to financial services.

Green Leaf Grocery - Executive Compensation Case Study

The primary purpose of this teaching case is to aid students in understanding how executive compensation plans are utilized to achieve organizational goals and to then construct their own executive compensation plan for the CEO of Greenleaf Grocery, a fictional retail business based on an actual company.
 Students have the opportunity to create a comprehensive executive compensation plan using salary, bonuses, stock options, benefits, and other compensation tools. Additionally, the case provides the opportunity to discuss the use of both short-term and long-term incentive compensation. The company in this case is poised to undertake an initial public offering of stock and retaining the current CEO is viewed as critical for this next phase. 
 The case affords the class the opportunity to explore ethical issues in executive compensation as well as other aspects of the organization’s overall compensation structure.

Applying economic psychology to the problem of executive compensation.

The conventional design of executive compensation plans is based on an outdated model of executive agency. Empirical work described in this article has provided a better understanding of the relationship between executives’ pay and their motivation by undertaking a detailed examination of the psychology of executive incentives. Four key points emerge. First, executives are much more risk averse than financial theory predicts. Secondly, executives are very high time discounters, thus reducing the perceived value of deferred rewards. Thirdly, intrinsic motivation is much more important than admitted by traditional economic theory. Fourthly, executives are more concerned about the perceived fairness of their awards relative to peers than in absolute amounts. Our research suggests that companies would be better off paying generous salaries, and using annual cash bonuses to incentivize desired actions and behaviors. Executives should be required to invest their bonuses in company shares until they have sufficient “skin in the game” to align their interests with shareholders. As far as possible the use of equity plans, especially complex, high-powered, performance-based plans should be kept to a minimum.

CEO Retirement, Corporate Governance and Conditional Accounting Conservatism

Based on 16,604 observations between 1994 and 2006, this study revisits the ‘horizon problem’ by examining how CEO retirement affects conditional accounting conservatism. We hypothesize and find that firms become less conservative in their financial reporting before the retirement of their CEOs, and that strong corporate governance mitigates the effect of CEO retirement. The literature concerning the horizon problem has suggested that CEOs manipulate earnings to boost short-term performance before they leave their companies (Dechow, P. M., & Sloan, R. G. (1991). Executive incentives and the horizon problem: An empirical investigation. Journal of Accounting and Economics, 14(1), 51–89; Smith, C. W., & Watts, R. L. (1982). Incentive and tax effects of executive compensation plans. Australian Journal of Management, 7(2), 139–157), but the evidence is mixed. By examining conditional conservatism, we avoid some of the methodological difficulties that confront researchers when examining either real or accrual earnings management. Ours is the first study to provide evidence on how the horizon problem shapes conditional accounting conservatism.

A Global Outlook on Executive Compensation: A Comparative Exploration

The global arena has become the battleground for organizations to find executives with human capital that can thrust high performance goals. Using an exploration of the extant literature, this paper focused on executive compensation from three different regional perspectives: The United States, European Union member-states, and Chinese. The author Sought to inquire about the pay- for-performance incentives and to evaluate both similar and dissimilar compensation structures across the globe by using three exemplars. In the same light, discussed are the various elements included in compensation. Provided is review of global compensation structure, along with pay-for-performance as main enticement for global executives. Frankly, this comparative paper identified that not all compensation plans were tied to pay-for-performance, while some were overtly tied to pay for performance due to the structure of the organizational risk-aversion and economic structure. This paper provides comparative review of executive compensation in three geographical regions. Reference points used as exemplars in this document consist of the: European Union, United States, and China. These exemplars were chosen because they have majority presence in the open exchange markets, and they are, to degree, dissimilar in as far as legal, environmental, and social aspects. The significance of this paper is to explain the differences in compensation in an attempt to show the advantages and disadvantages of the varying compensation structures, globally. Also to explore the role of pay-for-performance linked to executive performance. The presented compensation structures are reflections of culture, organizational performance, and the creation of motivating incentives to increase employee performance. From theoretical perspective, this paper seeks to fill the gap in the literature proposed by Phillips and Fox (1989) who asked what is the impact of the compensation strategy on those most directly affected - employees (p. 474). Secondly, Garhart and Fang (2013) proposed there is, a second avenue of needed research is to more comprehensively define and measure PFIP (pay-for-performance) and study its consequences (p. 10). And finally, Cooper, Gulen, and Rau agreed that, There is surprisingly little research on this important (pay-for-performance) topic, given that current compensation should be linked to future performance if the correct incentive contracts are used, which is the main reason this paper foci is on pay-for-performance and compensation concepts but on global scale. This paper seeks to fill in the gaps in the literature by clearly outlining the European Union, China, and the US compensation strategy and, to show if the executive compensation plans are diverging or converging based on performance-to-pay initiatives. The first section of this paper examined the Chinese compensation structure. The second section addressed the European Union member-states structure of compensation, and the final section explored the US based form of compensating executives. At the end of this paper practical implication and conclusion of the comparative analyses of international executive compensation are provided.

What Does “Say on Pay” Say about Audit Risk?

SUMMARY This paper examines a sample of 36 firms that received a majority of negative shareholder votes on their executive compensation plan in the first round of Dodd-Frank mandated “say-on-pay” voting in 2011. Relative to a control group, the 36 firms tend to perform poorly and have high CEO pay in the pre-vote period, and especially in 2010. We find that about 20 percent of the rejected firms also had income-decreasing restatements that impact the five-year period before the vote, compared to only 3 percent for a control group. The rejected firm sample also has weaker internal controls, as well as greater increases in audit fees in the year before the vote. The voting highlights how rejected firms tend to have higher audit risk environments in the years preceding the say-on-pay vote. In addition, since over half of the restatements occur after the say-on-pay vote, the findings also suggest that auditors should use voting as an input to their risk assessments.

The valuation of forward-start rainbow options

This paper studies the valuation and hedging problems of forward-start rainbow options (FSROs). By combining the characteristics of both multiple assets and forward-start feature, this new type of derivative has many potential applications, for instance, to incorporate the reset provision in rainbow options for investors or hedgers or design more effective executive compensation plans. The main contribution of this paper is a novel martingale pricing technique for options whose payoffs are associated with multiple assets and time points. Equipped with this technique, the analytic pricing formula and the formulae of the delta and gamma of the FSRO are first derived. We conduct numerical experiments to verify these formulae and examine the characteristics of the FSRO’s price and Greek letters. To demonstrate the importance and general applicability of the proposed technique, we also apply it to deriving the pricing formula for the discrete-sampling lookback rainbow options.

Creating an Executive Compensation Plan: A Corporate Tax Planning Case

ABSTRACT In this case, the student takes on the role of a compensation committee team member in a publicly traded corporation. The case task is to create a compensation plan for the company's CEO using past data regarding CEO compensation and specific incentives from proxy statements, along with financial statement performance data. To develop a comprehensive plan for the executive, students must incorporate numerous issues and course topics, both tax and nontax, applying them to the particular fact pattern. Pre- and post-case responses from students confirm that this case furthers their understanding of the interplay between corporate tax rules and executive compensation while cultivating critical thinking skills. The case has been used in both graduate tax and graduate accounting courses. To accommodate different teaching philosophies and course emphasis (tax or accounting), three variations of the project are provided.

A Look Back at the Beginnings of EVA and Value‐Based Management

One of the pioneers of value‐based management discusses his life's work in converting principles of modern finance theory into performance evaluation and incentive compensation plans that have been adopted by many of the world's largest and most successful companies, including Coca‐Cola in the U.S., SABMiller in London, Siemens in Germany, and the Godrej Group in India. The issues covered include the significance of dividend payouts (are dividends really necessary to support a company's stock price and, if so, why?) as well as the question of optimal capital structure (whether and why debt might not be cheaper than equity).But the most important focus of the interview is corporate performance measurement and the use of executive pay to strengthen management incentives to increase efficiency and value. According to Stern, the widespread tendency of public companies to manage “for earnings”—or in accordance with what he refers to as “the accounting model of the firm”—often leads to value‐destroying decisions. As one example, the GAAP accounting principle that requires intangible investments like R&D and training to be written off in the year the expenses are incurred is likely to cause underinvestment in such intangibles. At the same time, the failure of conventional income statements to reflect the cost of equity almost certainly encourages corporate overinvestment.Stern's solution to this problem is an executive incentive compensation plan in which rewards are tied to increases in a measure of economic profit called economic value added, or EVA, which research has shown to have a significance relation to changes both in share value and the premium of market value over book value. Moreover, by combining such a plan with a “bonus bank” that pays out annual awards over a multi‐year period, boards can ensure that management will be rewarded not for good luck but rather for sustainable improvements in performance.

Phantom Stock Executive Compensation Plans

Unlike the popular market-value stock options, stock awards and stock appreciation plans, phantom stock plans do not involve ownership of publicly-traded stock, although market-based stock may be used as a measurement of the phantom stock plan. Another popular method for valuing phantom stock plans is book value (i.e. assets minus liabilities). It is important to note that phantom stock plans can incorporate any design features of a market-based plan. However, under FAS 123R, phantom plans will be treated as a liability award and subject to a variable accrual, unlike market based plans which are considered equity awards and fixed accounting using a pricing model. The company has a tax deduction at time of the recipient having taxable income in the same amount of such income.

Influence of TARP regulations on executive compensation plans and corporate governance of ‘exceptional assistance’ recipients

Our article examines proxy statement disclosures to gain insight about the role of the Special Master, the requirement of a risk analysis of compensation plans and the requirement of a provision for compensation clawbacks for firms receiving ‘exceptional assistance’ under the Emergency Economic Stabilization Act of 2008. We examine the only three firms – AIG, Citigroup and Bank of America – that both received exceptional assistance and provided 2010 proxy statements. We find that the Special Master, in his capacity of reviewing and approving compensation payouts and compensation structures as a government representative, mitigated the costs of TARP restrictions by using his discretion to override some restrictions, such as allowing cash compensation in excess of the $500 000 maximum. We also observe significantly more compensation-related risk disclosures and a greater focus on risk in the design of compensation plans and choice of performance metrics after firms were required to analyze whether compensation plans motivate excessive risk-taking. All three firms appear to acknowledge concerns about their compensation plans, either explicitly by formally stating their concerns or implicitly by adopting new risk-related performance measures. In addition, we note that the amount of disclosure the three firms provide in responding to the same regulations differs significantly. Finally, we find that some firms adopted clawbacks beyond what is required, suggesting that firms find clawbacks beneficial in curbing excessive risk-taking. Our analysis of disclosures suggests that it would be useful for the SEC to review the resulting TARP disclosures as it determines whether such rules would be beneficial to impose on all firms.

Behavioral Agency Theory

This article describes new micro-foundations for theorizing about executive compensation, drawing on the behavioral economics literature and based on a more realistic set of behavioral assumptions than those that have typically been made by agency theorists. We call these micro-foundations “behavioral agency theory.” In contrast to the standard agency framework, which focuses on monitoring costs and incentive alignment, behavioral agency theory places agent performance at the center of the agency model, arguing that the interests of shareholders and their agents are most likely to be aligned if executives are motivated to perform to the best of their abilities. We develop a line of argument first advanced by Wiseman and Gomez-Mejia and put the case for a more general reassessment of the behavioral assumptions underpinning agency theory. A model of economic man predicated on bounded rationality is proposed, adopting Wiseman and Gomez-Mejia’s assumptions about risk preferences, but incorporating new assumptions about time discounting, inequity aversion, and the trade-off between intrinsic and extrinsic motivation. We argue that behavioral agency theory provides a better framework for theorizing about executive compensation, an enhanced theory of agent behavior, and an improved platform for making recommendations about the design of executive compensation plans.

CEO Personal Wealth, Equity Incentives and Firm Performance

AbstractManuscript TypeEmpiricalResearch Question/IssueIn this paper, we explore the determinants and performance effects of a novel measure of executive incentives, that is, the elasticity of a CEO's total wealth to firm performance, computed as a CEO's ownership value relative to her total wealth.Research Findings/InsightsUsing unique data on the total personal wealth of the CEOs of listed Swedish firms, we find that while CEOs typically own only a very small fraction of the shares of their firms, this ownership often constitutes a significant part of their total wealth. We also find that a CEO's total wealth elasticity is negatively associated with firm size and a CEO's age is positively associated with a firm risk environment. As for the effect on firm performance, we find that higher CEO's equity incentives enhance future accounting firm performance, when we estimate panel data regressions by taking into account the dynamic nature of endogeneity between a CEO's incentives and firm performance. However, we do not find any evidence that a CEO's equity incentives to be related to future stock returns.Theoretical/Academic ImplicationsOur analysis suggests that executives' incentives when measured as price‐performance elasticity are economically more significant than has been often argued in the literature. Moreover, due to several advantages of price‐performance elasticity over traditionally used fractional ownership and dollar‐at‐stake measures, the inferences drawn from this study with respect to determinants and performance implications of a CEO's incentives may be superior to those from prior studies. The result on the relation between firm size and a CEO's incentives is especially interesting, because, unlike fractional ownership, the elasticity of a CEO's total wealth to firm performance is not spuriously related to firm size. With respect to the relation between incentives and subsequent firm performance, our results are consistent with the view that higher CEO's incentives, measured as price‐performance elasticity, enhance firm accounting performance. Overall, future studies should consider price‐performance elasticity as an alternative measure of executive incentives in addressing various research questions.Practitioner/Policy ImplicationsThe evidence in this paper suggests that executive incentives calculated relative to their non‐firm wealth are economically more meaningful if compared to the traditionally used measures. As such, compensation consultants and boards of directors can consider this alternative measure when designing executive compensation plans and determining an appropriate level of ownership, when the information on executive non‐firm wealth is available.

CEO Personal Wealth, Equity Incentives and Firm Performance

Manuscript Type. Empirical. Research Question/Issue. In this paper, we explore the determinants and performance effects of a novel measure of executive incentives, that is, the elasticity of a CEO's total wealth to firm performance, computed as a CEO's ownership value relative to her total wealth. Research Findings/Insights. Using unique data on the total personal wealth of the CEOs of listed Swedish firms, we find that while CEOs typically own only a very small fraction of the shares of their firms, this ownership often constitutes a significant part of their total wealth. We also find that a CEO's total wealth elasticity is negatively associated with firm size and a CEO's age is positively associated with a firm risk environment. As for the effect on firm performance, we find that higher CEO's equity incentives enhance future accounting firm performance, when we estimate panel data regressions by taking into account the dynamic nature of endogeneity between a CEO's incentives and firm performance. However, we do not find any evidence that a CEO's equity incentives to be related to future stock returns. Theoretical/Academic Implications. Our analysis suggests that executives' incentives when measured as price‐performance elasticity are economically more significant than has been often argued in the literature. Moreover, due to several advantages of price‐performance elasticity over traditionally used fractional ownership and dollar‐at‐stake measures, the inferences drawn from this study with respect to determinants and performance implications of a CEO's incentives may be superior to those from prior studies. The result on the relation between firm size and a CEO's incentives is especially interesting, because, unlike fractional ownership, the elasticity of a CEO's total wealth to firm performance is not spuriously related to firm size. With respect to the relation between incentives and subsequent firm performance, our results are consistent with the view that higher CEO's incentives, measured as price‐performance elasticity, enhance firm accounting performance. Overall, future studies should consider price‐performance elasticity as an alternative measure of executive incentives in addressing various research questions. Practitioner/Policy Implications. The evidence in this paper suggests that executive incentives calculated relative to their non‐firm wealth are economically more meaningful if compared to the traditionally used measures. As such, compensation consultants and boards of directors can consider this alternative measure when designing executive compensation plans and determining an appropriate level of ownership, when the information on executive non‐firm wealth is available.

Auditing your executive compensation plan

AbstractCorporations' compensation practices have recently received increased scrutiny from investors, lawmakers, auditors, and regulators. Incentive pay packages, especially at financial firms, have been described as excessive and out of control. However, incentive plans remain a critical mechanism for firms to attract, reward, and motivate employees to work in ways to maximize firm value. Additionally, compensation costs are a significant expenditure that firms must continually manage and monitor. This article discusses why incentive compensation is important to firm management, barriers to effective incentive compensation, and suggestions for how CEOs, CFOs, and boards of directors can improve the link between incentives and the health of the firm. © 2012 Wiley Periodicals, Inc.

Does Shareholder Approval Requirement of Equity Compensation Plans Matter?

This paper studies the impact of the 2003 SEC Regulation requiring shareholder approval of all equity-based executive compensation plans on executive compensation policies and practices at S&P 500 firms. Following the 2003 Regulation, firms with shareholder approved equity plans in place or those with strong performance, while not those with non-approved plans or weak performance, increase their equity compensation proposal submission activity. The quality of equity compensation proposals improves in the after-regulation period, and shareholders exhibit greater scrutiny and monitoring of executive compensation through increased voting rights. We find a decline in the equity pay component while an increase in the cash component of total executive compensation after the 2003 Regulation and also provide evidence that the 2003 Regulation contributes to this change in compensation structure.

Does shareholder approval requirement of equity compensation plans matter?

This paper studies the impact of the 2003 SEC Regulation requiring shareholder approval of all equity-based executive compensation plans on executive compensation policies and practices at S&P 500 firms. Following the 2003 Regulation, firms with shareholder approved equity plans in place or those with strong performance, while not those with non-approved plans or weak performance, increase their equity compensation proposal submission activity. The quality of equity compensation proposals improves in the after-regulation period, and shareholders exhibit greater scrutiny and monitoring of executive compensation through increased voting rights. We find a decline in the equity pay component while an increase in the cash component of total executive compensation after the 2003 Regulation and also provide evidence that the 2003 Regulation contributes to this change in compensation structure.

A restaurant case study of lease accounting impacts of proposed changes in lease accounting rules

PurposeNew lease accounting rules are proposed that will fundamentally change the way leases are accounted for and reported in financial statements. This paper seeks to provide information on the proposed new rules and to illustrate their impact on financial statements and financial ratios using a single restaurant company.Design/methodology/approachThe case of a single restaurant company, CEC International, is used to illustrate the potential impact of the new rules. Additional examples are used to illustrate the impact on financial policies. Financial statements were adjusted and various financial ratios such as interest coverage, leverage and profitability ratios were computed before and after capitalization.FindingsThe results show that financial statements presented will change dramatically when lease assets and liabilities are added to the balance‐sheet. The expense recognition pattern will change significantly and negatively impact performance measures such as interest coverage and capital ratios but improve cash flow measures such as EBIT and EBITDA.Research limitations/implicationsLimitations of this study include the assumptions used to capitalize leases such as interest rate, life of leases, no new leases, and exclusion of contingent rentals.Practical implicationsAll restaurant companies and managers must assess the costs and benefits of complying with the proposed new rules and start analyzing and evaluating their impact on existing debt agreements, executive compensation plans, and the lease versus buy decision.Originality/valueThis paper serves to inform restaurant managers about the potential implications of the new rules, so managers can prepare, plan and formulate strategies to mitigate their impact.

The Financial Crisis and the Response of the United States: Will Dodd Frank Protect Us from the Next Crisis?

In July of 2010 Congress enacted the Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd Frank Act”). The Dodd Frank Act is the primary legislative response in the United States to the financial crisis of 2007-09. It makes wide-ranging and significant changes to a number of aspects of financial services regulation. This article examines the eight most significant initiatives undertaken in the Dodd Frank Act; initiatives which are intended to avoid the next financial crisis, to give regulators the tools to deal with a future crisis when it occurs and to substantially increase the levels of protection provided to U.S. consumers of financial services. The Act creates a new Financial Stability Oversight Council with the broad responsibility to anticipate and to take measures to avoid the next financial crisis. It gives to the Federal Deposit Insurance Corporation the authority to liquidate very large financial services companies in an orderly manner in the event they fail. It creates a new National Insurance Office in the Department of the Treasury to provide limited oversight of our state-regulated insurance industry and, more importantly, to collect information on the risk to the U.S. financial system generated by the failure of the largest insurance companies. It provides for more intensive and effective regulation of credit rating agencies, overseen by a new Office of Credit Ratings at the Securities and Exchange Commission. It imposes registration requirements on hedge fund advisers and provides a process for collecting information on the risks posed to the U.S. financial system by the investment activities of hedge funds. It mandates significant new regulation at the Commodities Futures Trading Commission and the Securities and Exchange Commission over the trading of derivatives, requiring exchange-based trading for some classes of derivatives and for transparency in the trading of customized derivatives not suitable for exchanges. It requires a variety of corporate governance reforms for publicly traded companies, including a “say on pay” (a shareholders’ advisory vote on executive compensation plans), increased disclosures to shareholders, independent board compensation committees and consultants, and board risk committees for large financial services companies. Finally, it creates a major new agency, the Bureau of Consumer Financial Protection, located in the Federal Reserve System with significant powers to protect consumers in their purchases of a broad range of financial products. Each of these eight initiatives undertaken in Dodd Frank is complex and dependent to a significant degree on the promulgation of regulations for its implementation. It remains to be seen if these regulations will reflect the spirit of Dodd Frank’s ambitious and serious approach to avoiding or, at least, to providing the tools to survive the next financial crisis. This article offers a summary and some comments on the Dodd Frank initiatives outlined above. The ultimate effect of the Dodd Frank Act will depend to a large extent upon how it is implemented by U.S. financial regulators.

Institutional Investors and Proxy Voting on Compensation Plans: The Impact of the 2003 Mutual Fund Voting Disclosure Rule

This article examines the impact on shareholder voting of the Securities and Exchange Commission (SEC)'s mutual fund voting disclosure rule, using a paired sample of management proposals on executive equity incentive compensation plans submitted before and after the rule change. In enacting the rule, the SEC intended to increase funds’ engagement in corporate governance. While voting support for management has decreased over time, we find no evidence that mutual funds’ support for management declined after the rule change, as expected by the SEC and advocates of disclosure. In fact, we find evidence of increased support for management by mutual funds after the change.