Question

#13 Suppose you are a director of an energy company that has three divisions—natural gas, oil, and retail (gas stations). These divisions operate independently from one another, but all division managers report to the firm’s CEO. If you were on the compensation committee, as discussed in Question 1-12, and your committee was asked to set the compensation for the three division managers, would you use the same criteria as that used for the firm’s CEO? Explain your reasoning

Here is # 12

12 Suppose you were a member of Company X’s board of directors and chairperson of the company’s compensation committee. What factors should your committee consider when setting the CEO’s compensation? Should the compensation consist of a dollar salary, stock options that depend on the firm’s performance, or a mix of the two? If “performance” is to be considered, how should it be measured? Think of both theoretical and practical (i.e., measurement) considerations. If you were also a vice president of Company X, might your actions be different than if you were the CEO of some other company?

Answer 1

The compensation policy of the divisional managers will obviously differ from the compensation of the CEO. The CEO of the organisation is meant to report to the Board of Directors. The CEO is meant to work towards achieving the long term goals of the organisation and add value to the shareholders. Thus, the compensation of the CEO would most probably include a component of ESOPs. However, the divisional managers are meant to report the CEO and help the individual businesses smoothly on a daily basis. Their compensation should comprise of a fixed compensation and a variable compensation which may be linked to the company's short term goal, i.e., the sales target, or the Cost of Goods Sold. Thus, the compensation of divisional managers may not necessarily include stock options.