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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.
Source: Heneman, Schwab, Fossum and Dyer, Personnel and Human Resource Management, 1989.
JDI: Job Descriptive Index; MSQ: Minnesota Satisfaction Questionnaire
Applications
Pay for performance ~14% of compensationCommissionsPiece workBonuses
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
Return from shirking:
At time T*: L+W if shirk and are not caught: Shirk if L + (1-P)*W > W
: L if shirk and are caught If P < 1, shirk at T*
: W if don’t shirk
P = probability of being caught shirking L
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
T*
MRP with shirking
Performance bonds and deferred compensation
Make sure PV(W) = PV(MRP)
Rationale for Mandatory retirement
MRP without shirking
WAGE
BOND
Deferred compensation
T*
Applications
Defined Benefit Pension PlansEmployee Retirement Income Security Act (ERISA)Pension guaranteed by the Pension Benefit Guarantee
Corporation
Pension underfundingPBGC 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)
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%.
Who Made the Biggest Bucks? Wall Street Journal April 10, 2006
TournamentsFirm 1
CEO $200,000*1
Exec VP $150,000*6
VP$100,000*12
Total $2,300,000
Expected Value of competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*50,000
= $8,333
Firm 2
CEO $560,000*1
Exec VP $130,000*6
VP $80,000*12
Total $2,300,000
Expected Value of competing
VP to EVP = .5*50,000
= $25,000
EVP to CEO= .167*430,000
= $71,810
Why bother?
TournamentsFirm 1CEO $200,000*1Exec VP $150,000*6VP
$100,000*12Total $2,300,000
Expected Value of being VP= 100,000 + .5*150,000 + (.5)*(.167)*200,000
= $191,700
Expected gain from competing = $91,700
Firm 2CEO $560,000*1Exec VP $130,000*6VP $80,000*12Total $2,300,000
Expected Value of being VP= 80,000 + .5*130,000 + (.5)*(.167)*560,000
= $176,760
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
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