Compensation: Benefits, wages, taxes
Employee 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.
JDI: Job Descriptive Index; MSQ: Minnesota Satisfaction Questionnaire
Source: Heneman, Schwab, Fossum and Dyer, Personnel and Human Resource Management, 1989.
Applications
Pay for performance ~14% of compensation
Commissions
Piece work
Bonuses
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
WAGE
MRP
Deferred compensation
BOND
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:
: L if shirk and are caught
: W if don’t shirk
P = probability of being caught shirking
L
W
T*
Shirk if L + (1-P)*W > W
If P < 1, shirk at 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
MRP with shirking
T*
Performance bonds and deferred
compensation
Make sure PV(W) = PV(MRP)
Rationale for Mandatory retirement
WAGE
MRP without shirking
Deferred compensation
BOND
T*
Applications
Defined Benefit Pension Plans
Employee Retirement Income Security Act (ERISA)
Pension guaranteed by the Pension Benefit Guarantee
Corporation
Pension underfunding
PBGC 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 plan
35
Benefit per year and Years to Receive Benefit
30
Pension amount
25
20
15
10
Years to collect pension
5
0
30
35
40
45
50
55
60
65
70
Age of Retirement
75
80
85
90
Present Value of Defined Benefit Package at Current Age
Annuity Benefit = 500*Work years
Cannot retire before 65, Expected lifespan = 90 years
350000
300000
250000
200000
$
150000
100000
50000
0
25
35
45
55
65
Age
75
85
95
Who Made the Biggest Bucks? Wall Street Journal April 10, 2006
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%.
Tournaments
Firm 1
CEO
Exec VP
VP
Total
$200,000*1
$150,000*6
$100,000*12
$2,300,000
Expected Value of
competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*50,000
= $8,333
Why bother?
Firm 2
CEO
Exec VP
VP
Total
$560,000*1
$130,000*6
$80,000*12
$2,300,000
Expected Value of
competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*430,000
= $71,810
Tournaments
Firm 1
CEO
Exec VP
VP
Total
$200,000*1
$150,000*6
$100,000*12
$2,300,000
Firm 2
CEO
Exec VP
VP
Total
$560,000*1
$130,000*6
$80,000*12
$2,300,000
Expected Value of being VP
= 100,000 + .5*150,000 +
(.5)*(.167)*200,000
= $191,700
Expected Value of being VP
= 80,000 + .5*130,000 +
(.5)*(.167)*560,000
= $176,760
Expected gain from
competing = $91,700
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 decreases
No further option for CEO except moving to bigger
firm