Compensation Policies

J. Falge, D. Hamacher, L. Sturges, M. Van Veen

Agenda

Introduction + problem statement

Overview of executive compensation Equity based compensation

Empirical evidence

BMW Case

Shell Case

Summary and Conclusion

General Overview

Bild durch Klicken auf Symbol hinzufügenGeneral overview

•Created in 2001 by 3 undergraduate students

•1400 employees worldwide

•Operating on 3 different continents in 8 different countries

•Market leader

Income Statement

2007 2008 2009 2010 2011 2012

Reveneues

Sales Revenue 20.000.000 19.000.000 17.500.000 23.500.000 26.000.000 32.000.000

Service Revenue 400.000 230.000 240.000 500.000 600.000 800.000

Total Revenue 20.400.000 19.230.000 17.740.000 24.000.000 26.600.000 32.800.000

Expenses

Advertising 2.000.000 2.000.000 2.500.000 2.500.000 2.500.000 3.000.000

COGS 11.000.000 8.000.000 7.000.000 10.500.000 12.000.000 13.500.000

Depreciation 150.000 190.000 250.000 130.000 180.000 200.000

Furniture&equipment 300.000 300.000 400.000 400.000 400.000 500.000

Insurance 125.000 125.000 125.000 150.000 150.000 150.000

Office Supplies 12.000 9.000 8.000 12.000 14.000 18.000

Rent 240.000 240.000 240.000 480.000 480.000 480.000

Research 1.500.000 1.000.000 1.000.000 1.500.000 1.500.000 2.000.000

Salaries 4.000.000 3.800.000 3.500.000 4.250.000 5.000.000 5.200.000

Travel 500.000 500.000 300.000 800.000 900.000 1.200.000

Total Expense 19.827.000 16.164.000 15.323.000 20.722.000 23.124.000 26.248.000

Net Income 573.000 3.066.000 2.417.000 3.278.000 3.476.000 6.552.000

Problem statement

Is there an optimal compensation package and what would it be in our

case?

Overview of executive compensation

Salary• Base of

compensation• Fixed

Bonus

• Based on firm/personal performance

• Non-equity

Equity

• Based on reported firm performance

• Shares/Stock options

Salary

Pro ConPro Con

Increases loyalty No incentive to maximize shareholder value

Easy to forecast

Less pressure

Lowers unhealthy competition

Tax restrictions (USA)

Usually minor part of package

Bonus

Pros ConsPros Cons

Encourages competition Discourages collaboration & teamwork

Maximizes profits Focuses too much on measuring profits

Clear measurable objectives

Short-term oriented

Only as good as objectives set

Equity

Pro Con

Empirical findings

Executives compensation and incentives

By Core, J.E., Guay, W.R., and, Larcker, D.F. (2003)

Managers holding stocks and options lowers monitoring costs

Gives managers incentives to maximize shareholder value.

Multiple firm characteristics needed to construct prediction of expected level of equity incentives

Empirical findings

Performance pay and top-management incentive

By Jensen, M. C., and Murphy, K.J. (1990)

Examines the value of equity-based compensation when

shareholder wealth increases

Estimated compensation: 3.25$ for 1000$ change

Conclusion: relatively small sensitivity

Empirical findings

Are CEOs really paid like bureaucrats?

By Hall, B.J., and Liebman, J. (1998)

CEO wealth often changes by millions of dollars for a

typical change in firm value

Strong and positive relation between performance and

CEO pay

Caused by equity-based compensation

Empirical findings

CEO incentives and earnings management

By Bergstresser, D., and Philippon, T. (2006)

Stock-based compensation leads to earnings management More incentivized CEO higher level of earnings

management

Significant amount of option exercises and share sales in periods of high earnings management

Empirical findings

Flights of fancy: corporate jets, CEO perquisites and inferior shareholder returns

By Yermack, D. (2006)

Disclosed personal use of company aircraft by CEOs is associated with significant underperformance: Use of corporate jets leads to an underperformance of the

market benchmarks by 4% At announcement, stock drops by an average of 1,1%

BMW Case

Executive bonuses linked to assembly line workers

Pressure from society and shareholders

Award upper and lower employees by same formula

Goal: fair and transparent compensation

Could this be a new trend in compensation policy?

Source: Bloomberg Businessweek

Shell Case

Source: Bloomberg

„Shell‘s numeration policy firmly links executive compensation with the

performance of the company, and the 2011 outcomes reflect what was a

positive year for the company“

Shell Case

Source: Shell annual Report

Increased Gross Profit +24.8 %Increased net income +53.6 %Increased EPS from 6.59 to 9.94

Outperformed FTSE by 23%

Shell Case

Source: Bloomberg

Long-term incentive;

6.5

Base salary; 1.55

Bonus; 3.5

Shell Case

Do you think the compensation package is adequate?

Shell Case

Source: Bloomberg

Responsible for over 200 oil spills in 2011

Systemetic contamination of 1000 Km² in the Niger delta

Worst pollution in Nigerias history

Increasing oil price

Do you still think his Compensation is adequate?

Shell Case

Source: Meme generator

Increases Oil spills

Doubles his salary

Compensation for our company

High or low base salary?

Long or short –term incentives?

Personal benefits?

Pay-performance compensation?

Conclusion

Salary

Bonuses

Equity-based compensation

Find perfect mix to allign intrest

Decrease Principal-agency conflict

References

Bloomberg Businessweek retrieved 18.03.2012 from http://www.businessweek.com/globalbiz/content/oct2009/gb20091027_769351.htm

Shell annual Report retieved 18.03.2012 from http://www.shell.com/home/content/investor/financial_information/annual_reports_and_publications/

Bloomberg retrieved 18.03.2012 from http://www.bloomberg.com/news/2012-03-15/shell-ceo-voser-s-compensation-more-than-doubles-on-awards.html

Questions?