Corporate Governance Executive Compensation & Incentives 1 — Questions and Answers
Question 1: What is a 'clawback' provision in executive compensation?
- A policy that requires executives to repay incentive compensation if financial results are restated (Correct answer)
- A tax provision that reduces executive bonus taxes
- A clause allowing executives to exit equity awards early
- A severance formula based on years of service
Correct answer: A policy that requires executives to repay incentive compensation if financial results are restated
Clawback provisions allow companies to recover previously paid incentive compensation if the company restates financials or if executive misconduct is discovered.
Question 2: What is the primary purpose of equity-based executive compensation?
- To minimize the company's cash outflow for salaries
- To align executive interests with long-term shareholder value creation (Correct answer)
- To comply with IRS tax deductibility limits on cash compensation
- To reduce the number of shares outstanding
Correct answer: To align executive interests with long-term shareholder value creation
Equity-based compensation like stock options and RSUs ties executive wealth to share price performance, aligning their interests with shareholders.
Question 3: Under IRC Section 162(m), what was the original limit on deductible executive compensation?
- $500,000 per executive
- $1 million per executive (Correct answer)
- $5 million per executive
- $10 million per executive
Correct answer: $1 million per executive
IRC Section 162(m) originally limited the tax deductibility of compensation paid to covered executives to $1 million per year.
Question 4: What is a 'restricted stock unit' (RSU)?
- A stock award that vests upon meeting specific performance conditions
- A company's promise to deliver shares upon satisfaction of vesting conditions (typically service-based) (Correct answer)
- A form of stock option with a discounted exercise price
- A share repurchase agreement between the company and an executive
Correct answer: A company's promise to deliver shares upon satisfaction of vesting conditions (typically service-based)
RSUs are promises to deliver shares after vesting conditions (usually time-based continued employment) are satisfied, and have value as long as the stock price is positive.
Question 5: What does the CEO pay ratio disclosure rule (SEC) require companies to report?
- The ratio of CEO total compensation to the median employee's total compensation (Correct answer)
- The ratio of CEO salary to CFO salary
- The ratio of executive bonuses to total payroll expense
- The ratio of CEO equity to total equity outstanding
Correct answer: The ratio of CEO total compensation to the median employee's total compensation
Under Dodd-Frank's CEO pay ratio rule, public companies must disclose the ratio of CEO total annual compensation to the median annual total compensation of all employees.
Question 6: Which compensation element is most directly linked to short-term company performance?
- Base salary
- Annual bonus (short-term incentive) (Correct answer)
- Long-term equity awards
- Pension benefits
Correct answer: Annual bonus (short-term incentive)
Annual bonuses are typically tied to one-year performance metrics like EBITDA or revenue growth, making them the most direct short-term incentive component.
Corporate Governance Executive Compensation & Incentives 1
What is a 'clawback' provision in executive compensation?