_________________________________________________________________
E M P L O Y E E B E N E F I T S , C O M P E N S A T I O N
& P E N S I O N L A W
Vol. 4, No. 15: August 14, 2003
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Publisher: LSN Employment, Labor, Compensation & Pension Journals
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Urban Institute
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Copyright: SSEP, Inc. 2003. All rights reserved.
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Topic of This Issue:
Compensation Issues
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T A B L E of C O N T E N T S
_________________________________________________________________
NEW and FORTHCOMING ARTICLES
"Further Evidence on Compensation Committee Composition as a
Determinant of CEO Compensation"
Financial Management, Vol. 32, No. 2, Summer 2003
NIKOS VAFEAS
University of Cyprus
"Aligning Incentives with Equity: Employee Stock Options and Rule
10b-5"
Iowa Law Review, Vol. 88, No. 3, pp. 539-600, March 2003
MATTHEW BODIE
Hofstra University
School of Law
"Six Challenges in Designing Equity-Based Pay"
Journal of Applied Corporate Finance, Vol. 15, Spring 2003
BRIAN HALL
Harvard University
Negotiations, Organizations and Markets Unit
National Bureau of Economic Research (NBER)
"Investment in Employee Stock Ownership Plans Clarified Through
Recent Developments"
Journal of Taxation of Investments, Vol. 20, No. 4, 2003
GREGORY K. BROWN
Gardner Carton & Douglas LLC
JEFFREY M. JOHNS
Shook Hardy & Bacon LLP
WORKING PAPERS
"Executive Loans"
KULDEEP SHASTRI
University of Pittsburgh
Katz School of Business
KATHLEEN M. KAHLE
University of Arizona
Department of Finance
"The Trouble with Stock Options"
BRIAN HALL
Harvard University
Negotiations, Organizations and Markets Unit
National Bureau of Economic Research (NBER)
KEVIN J. MURPHY
University of Southern California
Marshall School of Business
"Output-Based Pay: Incentives, Retention or Sorting?"
EDWARD P. LAZEAR
Stanford University
Graduate School of Business
Institute for the Study of Labor (IZA)
National Bureau of Economic Research (NBER)
S S R N I N F O R M A T I O N
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Benefits, Compensation & Pension Law we do not referee working
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N E W and F O R T H C O M I N G Articles
_________________________________________________________________
"Further Evidence on Compensation Committee Composition as a
Determinant of CEO Compensation"
Financial Management, Vol. 32, No. 2, Summer 2003
BY: NIKOS VAFEAS
University of Cyprus
Contact: NIKOS VAFEAS
Email: Mailto:bavafeas@ucy.ac.cy
Postal: University of Cyprus
Department of Public & Business Administration
75 Kallipoleos Street
Nicosia CY 1678, CYPRUS
Phone: +357 2 892-256
Fax: +357 2 339-063
Paper Requests:
Contact Financial Management Association Intl., at
Mailto:fma@coba.usf.edu Postal: University of South Florida,
College of Business Administration #3331, 4202 E. Fowler Ave.,
Tampa, FL 33620 USA. Phone: (813)974-2084. Fax: (813)974-3318.
ABSTRACT:
I use more than 1,500 firm-year observations for 271 U.S. firms
between 1991-1997 to examine the relation between insider
membership in compensation committees and CEO pay. I find a
steady decline in the number of committees with insider
participation during the sample period, and uncover some
opportunism by insiders in setting pay prior to the compensation
disclosure and tax reforms. Finally, I document changes in pay
practices that would be consistent with the intent of these
reforms. Based on this evidence, however, I cannot definitively
conclude whether the reforms were efficient.
______________________________
"Aligning Incentives with Equity: Employee Stock Options and Rule
10b-5"
Iowa Law Review, Vol. 88, No. 3, pp. 539-600, March 2003
BY: MATTHEW BODIE
Hofstra University
School of Law
Contact: MATTHEW BODIE
Email: Mailto:lawmtb@hofstra.edu
Postal: Hofstra University
School of Law
121 Hofstra University
Hempstead, NY 11549 UNITED STATES
Phone: 516-463-6162
Fax: 516-463-6338
ABSTRACT:
When the Internet boom was in full swing and the stock markets
skyrocketed to new levels, companies new and old used stock
options to attract and retain employees. Implicit in those
options was the promise that employees could participate in the
growth of a company's value. However, as the scandals involving
WorldCom, Enron, and Global Crossing demonstrate, corporate
managers were not always honest with employees or public
investors about the company's true value. Public investors can
seek civil remedies for securities fraud through a private
action under the Securities and Exchange Commission's Rule
10b-5. The Rule's "purchase or sale" requirement, however, has
been interpreted to exclude employees who receive their options
through a group plan rather than through individual negotiation.
Employees who individually negotiate for an employment package
including options are deemed to have "purchased" their options;
employees who receive their options through a group plan are
deemed to not have purchased them. This formalistic disparity
favors executives, managers, and other high-level employees who
individually negotiate for their employment contracts; employees
who receive their options en masse are left out in the cold.
This article argues that distinguishing between employees
based on their method of obtaining stock options is wrong, both
as a matter of doctrine and policy. The doctrinal distinction
between negotiated options and groups plans is based on an
outmoded theory about employment contracts - a theory that, in
the past, deemed employer pension promises to be a mere
gratuity. An employer's offer of stock options - just like
health benefits - is a binding contract once the employee
accepts that offer by working. On a policy level, employees who
receive their options through a group plan are, in fact, more
likely than their individual-negotiation counterparts to need
the antifraud protections that Rule 10b-5 affords. Although
employees may have certain informational advantages over outside
investors, they are often just as susceptible to managerial
fraud. The possibilities of employee strike suits or the
chilling of option grants are not sufficiently important to
warrant the elimination of antifraud security. And other legal
avenues, such as contract law or ERISA, do not provide the same
protections as Rule 10b-5. Ultimately, the article concludes
that all employees should be able to pursue relief under Rule
10b-5 for fraud that materially affects the value of their
options.
Keywords: employee stock options, Rule 10b-5, securities
fraud, employment contract
JEL Classification: K12, K22, K31
______________________________
"Six Challenges in Designing Equity-Based Pay"
Journal of Applied Corporate Finance, Vol. 15, Spring 2003
BY: BRIAN HALL
Harvard University
Negotiations, Organizations and Markets Unit
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=424170
Paper ID: Harvard NOM Working Paper No. 03-40
Contact: BRIAN HALL
Email: Mailto:BHALL@HBS.EDU
Postal: Harvard University
Negotiations, Organizations and Markets Unit
Soldiers Field
Boston, MA 02163 UNITED STATES
Phone: 617-495-5062
Fax: 617-496-4191
ABSTRACT:
During the past two decades, there has been a dramatic increase
in equity-based pay for executives. This paper analyzes why the
primary goal of the equity-pay explosion--creating long-run
ownership incentives for top executives--has often been
difficult to achieve in practice. More generally, I describe six
challenges in the design of equity-based pay plans and discuss
potential solutions. The six challenges involve:
1. mismatched time horizons;
2. gaming;
3. the value-cost "wedge";
4. the leverage-fragility tradeoff;
5. aligning risk-taking incentives; and
6. avoiding excessive compensation.
The paper also discussed the merits of stock versus options
and concludes that restricted stock is often a superior form of
compensation.
Keywords: Executive Compensation, Stock Options, Restricted
Stock, CEO Pay, Corporate Governance, Equity-based Pay
JEL Classification: J33, G34
______________________________
"Investment in Employee Stock Ownership Plans Clarified Through
Recent Developments"
Journal of Taxation of Investments, Vol. 20, No. 4, 2003
BY: GREGORY K. BROWN
Gardner Carton & Douglas LLC
JEFFREY M. JOHNS
Shook Hardy & Bacon LLP
Contact: GREGORY K. BROWN
Email: Mailto:gkbrown@gcd.com
Postal: Gardner Carton & Douglas LLC
321 North Clark Street
Suite 3400
Chicago, IL 60610 UNITED STATES
Co-Auth: JEFFREY M. JOHNS
Email: Mailto:jmjohns@shb.com
Postal: Shook Hardy & Bacon LLP
84 Corporate Woods
10801 Mastin, Suite 1000
Overland Park, KS 66210-1671 UNITED STATES
ABSTRACT:
An employee stock ownership plan ("ESOP") is a defined
contribution retirement plan designed to invest primarily in
stock of the sponsoring employer (or an affiliated employer)
that finances the purchase of such stock through a loan from, or
guaranteed by, the sponsoring employer. In accordance with
applicable regulations, a leveraged ESOP holds the employer
securities acquired with an ESOP loan in a "suspense account."
As the ESOP repays the loan over time, shares are released from
the suspense account and allocated to participant accounts
according to a specified formula. The operation of an ESOP
involves a variety of fiduciary and tax issues and situations,
such as whether or when to sell employer stock and what to do
about outstanding debt when employer stock is sold, and how the
S Corporation rules integrate with the operation of an ESOP.
This article explores recent developments in the area, and
describes the significance of those developments to
practitioners.
______________________________
W O R K I N G P A P E R Abstracts
_________________________________________________________________
"Executive Loans"
BY: KULDEEP SHASTRI
University of Pittsburgh
Katz School of Business
KATHLEEN M. KAHLE
University of Arizona
Department of Finance
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=423447
Paper ID: EFA 2003 Annual Conference Paper No. 184
Date: February 2003
Contact: KULDEEP SHASTRI
Email: Mailto:kuldeep@katz.pitt.edu
Postal: University of Pittsburgh
Katz School of Business
340 Mervis Hall
Pittsburgh, PA 15260 UNITED STATES
Phone: 412-648-1708
Fax: 412-648-1693
Co-Auth: KATHLEEN M. KAHLE
Email: Mailto:kkahle@eller.arizona.edu
Postal: University of Arizona
Department of Finance
McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108 UNITED STATES
ABSTRACT:
This paper analyzes the characteristics and impact of loans made
to executives for purposes of stock purchase, option exercise
and relocation. We find that loans made to assist executives in
purchasing stock or excercising options are larger and have
higher interest rates than relocation loans. All types of loans,
however, are issued at below-market interest rates, on average.
We also find while stock purchase loans are given to managers
with low existing ownership, option exercise loans are given to
managers with high existing ownership and high cash
compensation. Finally, our results indicate that executive stock
ownership increases follwong stock purchase and option exercise
loans. For managers as a whole, a loan that enables a manager to
buy 100 shares of stock results in only an eight-share increase
in ownership. However, the relation between ownership changes
and stock purcahse loans is much stronger for low ownership
managers.
______________________________
"The Trouble with Stock Options"
BY: BRIAN HALL
Harvard University
Negotiations, Organizations and Markets Unit
National Bureau of Economic Research (NBER)
KEVIN J. MURPHY
University of Southern California
Marshall School of Business
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=415040
Other Electronic Document Delivery:
http://www.ssrn.com/link/HBS-NOM-Unit.html
SSRN only offers technical support for papers
downloaded from the SSRN Electronic Paper Collection
location. When URLs wrap, you must copy and paste
them into your browser eliminating all spaces.
Paper ID: Harvard NOM Working Paper No. 03-33
Date: May 2003
Contact: BRIAN HALL
Email: Mailto:BHALL@HBS.EDU
Postal: Harvard University
Negotiations, Organizations and Markets Unit
Soldiers Field
Boston, MA 02163 UNITED STATES
Phone: 617-495-5062
Fax: 617-496-4191
Co-Auth: KEVIN J. MURPHY
Email: Mailto:kjmurphy@usc.edu
Postal: University of Southern California
Marshall School of Business
Hoffman Hall 701
Los Angeles, CA 90089-1427 UNITED STATES
ABSTRACT:
The trouble with options is that too many options are granted to
too many people. Most options are granted below the
top-executive level, and options are often an inefficient way to
attract, retain and motivate executives and (especially)
lower-level employees. Why, then, are options so prevalent? We
discuss several explanations including changes in corporate
governance, reporting requirements, taxes, the bull market and
managerial rent-seeking. We also offer an alternative hypothesis
that we believe explains the over-use of options and several
apparent puzzles: boards and managers falsely perceive stock
options to be inexpensive because of accounting and cash-flow
considerations.
Keywords: Executive Compensation, Stock Options, Equity-based
Pay, CEO Pay, Corporate Governance, Executive Labor Markets
JEL Classification: J00, J33, G34, L20
______________________________
"Output-Based Pay: Incentives, Retention or Sorting?"
BY: EDWARD P. LAZEAR
Stanford University
Graduate School of Business
Institute for the Study of Labor (IZA)
National Bureau of Economic Research (NBER)
Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=403900
Other Electronic Document Delivery:
ftp://ftp.iza.org/dps/dp761.pdf
SSRN only offers technical support for papers
downloaded from the SSRN Electronic Paper Collection
location. When URLs wrap, you must copy and paste
them into your browser eliminating all spaces.
Paper ID: IZA Discussion Paper No. 761
Date: April 2003
Contact: EDWARD P. LAZEAR
Email: Mailto:lazear@stanford.edu
Postal: Stanford University
Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015 UNITED STATES
Phone: 650-723-9136
Fax: 650-723-0498
Paper Requests:
Contact: Mark Fallak, Institute for the Study of Labor (IZA),
P.O. Box 7240, D-53072 Bonn, Germany. Phone:+49-228-3894-0 ext.
223. Fax:+ 49-228-3894-510. Mailto:Fallak@iza.org
ABSTRACT:
Variable pay, defined as pay that is tied to some measure of a
firm's output, has become more important for executives of the
typical American firm. Variable pay is usually touted as a way
to provide incentives to managers whose interests may not be
perfectly aligned with those of owners. The incentive
justification for variable pay has well-known theoretical
problems and also appears to be inconsistent with much of the
data. Alternative explanations are considered. One that has not
received much attention, but is consistent with many of the
facts, is selection. Managers and industry specialists may have
information about a firm's prospects that is unavailable to
outside investors. In order to induce managers to be truthful
about prospects, owners may require managers to "put their money
where their mouths are," forcing them to extract some of their
compensation in the form of variable pay. The selection or
sorting explanation is consistent with the low elasticities of
pay to output that are commonly observed, with the fact that the
elasticity is higher in small and new firms, with the fact that
variable pay is more prevalent in industries with very technical
production technologies, and with the fact that stock and stock
options are a larger proportion of total compensation for higher
level employees. The explanation fits small firms and start-ups
better than larger, well-established firms.