Compensation: Benefits, wages, taxesEmployee Benefits as a Percent of Compensation

TABLE 5.3 Employee Benefits as a Percentage of Total Compensation, 1999 (Average Yearly Cost in Parentheses)

Characterization of Market

Indifference curve: Combinations of benefits and wages that yield the same level of utility

Isoprofit line: Combinations of benefits and wages that yield the same level of profit

Applications

Cafeteria Plan

Profit sharing vs. Wages

Diversification

Employee Stock Ownership Plans (ESOP)

Polaroid employees give up 8% of salary for ESOP

Stock valued as high as $60, closes at $.09 in 2001.

Source: Heneman, Schwab, Fossum and Dyer, Personnel and Human Resource Management, 1989.

JDI: Job Descriptive Index; MSQ: Minnesota Satisfaction Questionnaire

Applications

Pay for performance ~14% of compensationCommissionsPiece workBonuses

Piece rate workers earn more than straight time paid workers

Does this mean piece rates motivate?Why aren’t piece rates more common?

Performance bonds and deferred compensation

MRP

WAGE

BOND

Deferred compensation

Performance bonds and deferred compensation

L = value of leisure

W = Wage

= MRP if don’t shirk

T*

Performance bonds and deferred compensation

Return from shirking:

At time T*: L+W if shirk and are not caught: Shirk if L + (1-P)*W > W

: L if shirk and are caught If P < 1, shirk at T*

: W if don’t shirk

P = probability of being caught shirking L

W

T*

Performance bonds and deferred compensation

More generally: return from shirking:

PV(W) = present value of wage stream

PV(L) = present value of leisure consumption

Shirk if PV(L) + (1-P)*PV(W) > PV(W) or PV(L) > P*PV(W)

L

W

T*

Performance bonds and deferred compensation

Shirk if PV(W) or PV(L) > P*PV(W)

As time T*, PV(W) gets smaller relative to PV(L) which means people will start to shirk, which means that true MRP will be less than W

L

W = MRP without shirking

T*

MRP with shirking

Performance bonds and deferred compensation

Make sure PV(W) = PV(MRP)

Rationale for Mandatory retirement

MRP without shirking

WAGE

BOND

Deferred compensation

T*

Applications

Defined Benefit Pension PlansEmployee Retirement Income Security Act (ERISA)Pension guaranteed by the Pension Benefit Guarantee

Corporation

Pension underfundingPBGC at risk for insuring $450 billion of underfunded private pensions

Current public sector underfunding $700 billion (more than all state and local property, sales and corporate tax)

Example of a defined benefit planExample of a defined benefit plan

Richard D. Fairbank, Capital One Financial Corp $249.27 Shareholder return: 2.7%.

Bruce Karatz, KB Home, $155.9 million. Shareholder return: 61%.

Henry R. Silverman, Cendant Corp., $133.26 million. Shareholder return: -21%.

Richard S. Fuld Jr., Lehman Brothers Holdings Inc., $104.4 million. Shareholder return: 51.6%

William E. Greehey, Valero Energy Corp., $95.16 million. Shareholder return: 128.5%.

Ray R. Irani, Occidental Petroleum Corp., $83.96 million. Shareholder return: 38.8%.

Lawrence J. Ellison, Oracle Corp., $74.37 million. Shareholder return: 12.3%.

Who Made the Biggest Bucks? Wall Street Journal April 10, 2006

TournamentsFirm 1

CEO $200,000*1

Exec VP $150,000*6

VP$100,000*12

Total $2,300,000

Expected Value of competing

VP to EVP = .5*50,000

= $25,000

EVP to CEO= .167*50,000

= $8,333

Firm 2

CEO $560,000*1

Exec VP $130,000*6

VP $80,000*12

Total $2,300,000

Expected Value of competing

VP to EVP = .5*50,000

= $25,000

EVP to CEO= .167*430,000

= $71,810

Why bother?

TournamentsFirm 1CEO $200,000*1Exec VP $150,000*6VP

$100,000*12Total $2,300,000

Expected Value of being VP= 100,000 + .5*150,000 + (.5)*(.167)*200,000

= $191,700

Expected gain from competing = $91,700

Firm 2CEO $560,000*1Exec VP $130,000*6VP $80,000*12Total $2,300,000

Expected Value of being VP= 80,000 + .5*130,000 + (.5)*(.167)*560,000

= $176,760

Expected gain from competing = $96,760

Forbes Magazine CEO Survey of the 800 largest publicly held firms

Of 800 CEOs

26 Founders

Of 774 firms not run by founders

694 (90%) internal promotions

80 (10%) external hires

Tournaments

Why should you have larger raises as job level rises?

1) Probability of promotion gets smaller

2) Number of future contests decreasesNo further option for CEO except moving to bigger

firm