“CEO Pay Design”
This purpose of this exercise is to help analyze the components of a compensation plan for executives. Read the short case below and answer the questions.
Building an Executive Compensation Package
The executives at Safeguard Insurance are focused on continuing efforts that have brought the company significant growth in the past 15 years. Director of Human Resources Beth Frazier is considering how to provide more incentives to executives to continue this focus. She knows that company ownership can help incentivize executives to increase the value of the company stock, and thus the ongoing success of the company.
Beth is working with the company’s board of directors to examine the compensation structure of the company’s leaders, and believes that a more direct tie to the company’s stock value may add just the right incentive for executives. Tying executive compensation to the stock value will provide a clear incentive for executives to increase the overall value of the stock (which would likely be in the best interest of the company).
Stock Options vs. Phantom Plan?
Initially, Beth thought granting the executives annual incentive stock options would create the right incentive for the team. By doing so, the company would grant the executives the option to purchase stock later at the price on the date of the grant. The executives would then have an incentive to grow the stock value over time.
However, a member of the board of directors suggested considering offering a phantom stock plan instead. A phantom stock plan exists when executives are compensated with hypothetical company shares rather than actual shares of company stock. Upon meeting certain performance conditions, executives receive income that is equal to the increase in the value of the company stock from the date that the phantom stock was granted until the conversion date.
1. How does a stock option plan provide an incentive for executives?
2. Which plan do you think would be better for Safeguard Insurance, the incentive stock option plan or the phantom stock plan?
Which Separation Agreements?
Many executive compensation plans contain a golden parachute clause, which provides pay and benefits to executives after a termination due to a change merger, takeover, or change in ownership. That way, if a merger or takeover occurs (think of Twitter being bought by Elon Musk), CEOs are still left with some compensation and benefits. Other executive compensation packages may contain a platinum parachute, which pays CEOs with lucrative severance pay and continuation of benefits. This is intended to prevent long legal battles or criticisms from the CEO, essentially by paying off CEOs to give up their posts.
3. In the event of a merger, how does a golden parachute avoid a conflict of interest between CEOs and the company’s well-being? Why would it be in Beth’s interest to include a Golden Parachute in her executives’ compensation package?
4. Due to its stellar performance, Safeguard Insurance has been the target of recent buyout acquisitions from larger companies like GEICO and StateFarm. Which plan do you think Beth should choose for her executives? The golden parachute or the platinum parachute?
