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Trial lecture Executive compensation: Governing the CEO or paying the price Sven-Olof Collin CORPORATE GOVERNANCE Exogenous Forces, i.e., Environment Legislation, culture, regulation, mass media etc Corporate Governance Mechanisms: Capital Owner/ Managerial labour Corporate Executive compensation Performance Principal Entrepreneurship of the Corporation Board Auditors Strategy & Structure Product market Part of the Environment effectiveness EXECUTIVE COMPENSATION • High salaries • Bonus • Option schemes THE COMPENSATION PUZZLE 40% Size of the firm Executive Pay Performance of the firm 5% COMPENSATION PUBLICITY Percy Barnevik (ABB): Börje Ekholm (Investor): Terminal payment: Profit sharing (terminal 901.000.000SKr, payment): 111.000.000SKr repay: 548.000.000SKr, in pocket: 353.000.000SKr Keith McLoughlin (Electrolux): First year salary: 74.500.000Skr Foppa (Ice hockey): 105.000.000SKr Zlatan (Soccer): 81.000.000Skr EFFICIENT INCENTIVES • Problem of governance: Align shareholder interest and CEO interest • Goal: Maximize shareholder value • Influence behavior of CEO through incentives: Correlation pay – share value => Payment in shares or options (right to buy a share at a predetermined price) Termed: “Strong efficient incentives” INCENTIVES CORRELATION PAY - PERFORMANCE • Piece work payment (potato harvest) • Induce a kid to clean the room My effort is only a function of my compensation CRITERIA FOR COMPENSATION • Performance • Behaviour • Individual characteristics • Labour market price • Position • Peer comparison salary CEO COMPENSATION – AN IMPORTANT PART OF THE ORGANIZATIONS INCENTIVE SYSTEM Winnings SKr productivity Bets year Options are a CEOs best friend • Family ownership reduce level of CEO compensation • Ownership concentration reduce propensity to use options • Conclusion: CEOs should pick firms with international investors and dispersed ownership = High wage and options SELECTION SYSTEM • Selection of managers – Skills – Norms Þ Survival of those that do not need incentives every second Þ Survival of those with good norms, i.e., relvant duty SANCTION SYSTEM • Inclusion & exclusion: Belongingness • Cost of exit: The golden prison WHEN DO WE NEED THE STIMULUS OF INCENTIVES Following wind, flat rod Muddy road, adverse wind CASH FLOW - PAY GOOD TIMES BAD TIMES • WHEN CAN YOU AFFORD BIG SALARIES? • WHEN DO YOU NEED BIG SALARIES? PAY – PERFORMANCE? Pay when you have money Promise (i.e., option) when you do not have money CONCLUSION • CEOs are not 5 years old kids • Compensation function of … performance, market price, golden prison etc • Compensation part of organizational incentives • Individuals act because they have to act • Compensation in accordance with traditions • Compensation a function of cash flow POWER?
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