Employee Benefits as a Percent of Compensation

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

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

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.

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
Shirk if L + (1-P)*W > W
If P < 1, shirk at T*
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
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*

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
20
15
10
5
35
30
25
Benefit per year and Years to Receive Benefit
Pension amount
Years to collect pension
0
30 35 40 45 50 55 60 65 70
Age of Retirement
75 80 85 90

350000
300000
250000
$
200000
150000
100000
50000
0
25
Present Value of Defined Benefit Package at Current Age
Annuity Benefit = 500*Work years
Cannot retire before 65, Expected lifespan = 90 years
35 45 55
Age
65 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%.

Firm 1
CEO
Exec VP
VP
Total
Tournaments
$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 competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*50,000
= $8,333
Why bother?
Expected Value of competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*430,000
= $71,810

Firm 1
CEO
Exec VP
VP
Total
Tournaments
$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

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