Executive Compensation Professor Srividya Iyengar Coverage Classification of

Executive Compensation Professor Srividya Iyengar

Coverage Classification of Executive Compensation Calibration of Exec. Compensation to Performance Theories of Exec. Compensation Principles of Executive Compensation Factors affecting Executive Compensation Models of Executive Compensation Different Criteria for Exec. Compensation Process of Setting Executive Compensation Legal Environment for Exec. Comp in India

Calibration of Exec. Compensation to Performance High Pay / High Performance Low Pay / Low Performance Low Pay / High Performance Pay High Pay / Low Performance High

Theories of Executive Compensation Agency theory, Actions and Model Tournament theory Social comparison theory Balance sheet approach HQ-based pay Golden handcuffs Competency based pay Golden Parachutes Cafeteria plan

Agency Theory Principals (shareholder)s are risk neutral or risk averse Agents (Executives) are risk-averse or risk neutral Material incentives are necessary and sufficient to motivate executives to work Higher sum of monetary compensation causes higher executive effort; The efforts put in by an executive is sometimes difficult to observe i. e. , it is not tangible. And intangible efforts are difficult to quantify and reward

Sequence of actions Shareholders create a contract having or not the condition of awarding incentives Shareholders pay for work provided including incentives Shareholders (through the BOD) evaluate results Step 6 Step 5 Step 1 Step 4 Step 2 Step 3 Executives handle a work Executives acceptance or non acceptance Executives decide on quantity and quality of work they want

Model of Agency Theory

Principles of Executive Compensation Attracting and retaining executive talent Upholding shareholders interest Performance based compensation Effective compensation committee Executives to shareholders Compliance of law Transparent disclosure

Factors affecting Executive Compensation Changing nature of work Investors confidence Effective benchmarking Factors Affecting Executive Compensation Governance Attracting & retaining high performing executives Fostering right executive behaviours

Models of Executive Compensation Optimal Contracting Model ◦ EC is designed to reduce agency cost ◦ Market for managerial talent, capital, product and corporate control-preclude executives from earning excessive compensation ◦ Arms length bargaining

Contd… Managerial Power Model ◦ Executive’s ability to manipulate the compensation ◦ Set their compensation as shareholders are diffused and uninterested in corporate governance, generally preferring liquidity to control ◦ Executive have considerable influence including The power of the CEO over appointment of directors The ability of the CEO to reward cooperative directors Social and psychological influences Cognitive biases of directors tat come from being CEO’s Time and information barriers most directors face to making an informed and reasoned decision about compensation ◦ Not negotiated at arm’s length

Different criteria Exec. Compensation Strategy Role or Position Individual characteristics Performance Behaviour Size Market Peer compensation

Process of Setting Executive Compensation Board of Directors Shareholders decide EC Corporate Governance Setting Executive Compensation Mechanism to scrutinize EC Pay for Performance Government Regulations U/S 198 of The Companies Act 1956 To Link EC with organizational performance Market for Managerial Talent Engagement of compensation consultants

Legal Environment for Exe. Comp in India Boothalingam Committee ◦ Compensation differential between lowest and highest salary was in the range of 1: 10 ◦ Suggested for setting up National Pay Commission for fixing executive compensation Sachar Committee ◦ Role of government in regulating executive compensation should be reduced ◦ Universal norms to be prescribed for everyone to follow ◦ Shareholders should be taking a decision on executive compensation