Case Report on Executive Compensation

In the modern society, chief executive officer has become the most important part to many companies especially to the publicly listed corporations. They generally make a significant contribution to the profitability of their firm. However, in some case the managers’ interests conflict with their companies’, and thus their decisions may probably do not maximize their companies’ value. Therefore, it is a problem that how shareholders ensure that top executives want to maximize their wealth. This paper explores the principle for compensation, makes an attempt to design a new compensation package to the chief executive officer of Nike, Inc., and finally compare the different between the existing pay package and the new one.

I. Introduction

Nike, which originally named as Blue Ribbon Sports, is the largest manufacturer of the athletic footwear and apparel in the world, and one of the Fortune 500 companies. Figure1 shows that Nike is the leader of the global athletic footwear market, with around 31% market share in 2007. Creating by Bill Bowerman and Philip Knight in 1962, its early products are footwear, but now it has a wide range of product line. Today Nike is engaged in design, development and marketing of footwear, apparel and equipment, including shoes, sock, gloves, bags, and sports balls and so on. Many of its products are design for specific athletic such as football, basketball, running and even walking. According to figure2, Nike branded footwear contributes about 43.6% of Nike’s stock, while Nike branded apparel constitutes around 24.7%. It means that Nike branded footwear and apparel is the most important parts of its product line.

Because the importance and popularity of sport, the sportswear market has a huge profit, a great prospect, and a fierce competition. Nike major competitors include Adidas, Puma, and New Balance. Although on such a competitive market, its company value keeps growing every year because of innovation. It can be seen clearly from figure3 that the stock price of Nike increased over the last decade. Today it establishes retail stores in more than 160 countries, employs more than 33,000 people around the world.

Packer, Mark has been President and Chief Executive Officer of NIKE since January 23, 2006. In 1979, he employed by Nike as one of the first footwear designers. For more than thirty years, he brought innovative concepts and expertise into product design, and leading the continued growth of Nike brand. What’s more, it can be seen from Nike’s website that Parker is responsible for the growth of Nike, Inc.'s global business portfolio, which includes Cole Haan, Converse Inc., Hurley International LLC, and Umbro Ltd.

II. Analysis

This section explores the principles for compensation, analyses the existing pay package of Packer, Mark, and then present a new one.

As mentioned above, CEOs play an important role in their firm, especially in the United Stated, where ownership and control is separated in most of company. They responsible for almost everything of the company such as operations, financing, marketing, sales hiring, firing, human resources, setting strategy, building company culture, leading the senior management team and so on. However, the interests of most managers are their salary, reputation, and short-term performance of the company, while shareholders naturally focus on maximizing the firm value, and long-term development of the company. It means that sometimes managers’ interests conflict with shareholders’, or they face various tempting alternatives when making decisions. It probably leads to their investment decisions that do not maximize investor wealth, or in other words, they maximize their own utility rather than firm value, if the system of incentives does not work effectively. This kind of situations called agency problem. In order to alleviate the agency problem and to improve the correctness of capital investment decisions, the compensation plan must be design to give CEOs a right incentive (cited in Corporate Finance, 2006:306).

To design a new compensation package, the level of total pay should be considered first. As the trend of globalization, many American international corporations including Nike can hire cheaper labor from developing countries, so the salary gap between top executive and typical production workers will unceasingly widened. The next point is globalization leads to greater competition for talent. As the result, shareholders have to provide a higher pay to their top executive, in order to urge the person with ability to stay and service for their company. As Murphy pointed out, the company size is greater, the higher CEO pay (cited in Executive Compensation, p651). On the other hand, a high level of executive pay is simply reflects the intense competition to hire CEO rather than a necessary inducement to try harder (cited in Corporate Finance, 2006:308). It means that a high level of total pay is not the only way to solve agency problem. We also need an effective system of incentive.

As the matter of fact, most of CEO pay packages include five basic components: a base salary, an annual bonus tied to accounting performance, options on the company stock that typically vested or exercisable over time, long-term incentive plans including restricted stock plans and multi-year accounting-based performance plans, and other benefits such as pension and parachute. In the United States, it is a common situation that the base salary constitutes only a small proportion of CEOs total compensation. Instead, bonuses that are based on company accounting measures and long-term incentives, such as stock option plans that allow CEO to buy the company’s stock at a specified price, accounted for a large portion (cited in Corporate Finance, 2006:308). The income of American CEO is much more performance-based than most countries.

Table1 shows the compensation package of Parker, Mark for fiscal 2010, according to an Associated Press analysis of a recent regulatory filing by the shoe and apparel company. It can be seen clearly that the total value of his compensation package is nearly 13.1 million dollars — more than 84 percent increase from last year. The reason is that Nike didn't meet its financial performance goals, Packer’s non-equity incentive plan compensation was low last year. Nike exceeded its financial goals for fiscal 2010, so the company grants Parker 4.4 million dollars in an annual performance-related cash bonus, which accounted for the majority of his compensation value growth. His salary valued at about 1.5 million dollars, less than the value of his stock options and cash performance bonus. Besides, the company also gave him other compensation of around 0.19 million dollars every year — including contributions to retirement funds and an anniversary service award for the chief executive. On the other hand, Adidas, who has been seen as one of Nike’s biggest competitors, have a different pattern, compare with Nike. As table2 has shown below, base salary took up a large portion of total pay of the CEO of Adidas. The same point between them is their long-term incentive plans, which both depend on the company financial performance to a great extent.

After analysis the data is it not difficult to design a new compensation package to Parker, Mark. Personally, I recommend that the salary of Packer, Mark should rise to about 1.5 million dollars, because of the company’s excellent performance during fiscal 2010. But there is a problem that since 1994 compensation of more than one million dollar paid to top executives is considered unreasonable and cannot be deducted as an expense for tax purpose (cited in Corporate Finance, 2006:308). It means that the base salary should not be too high. In this case the stock options may be better than cash payment, so I suggest paying Packer more compensation in stocks option. The option should be a call option, which gives Packer a right to buy the firm’s stock at a cheaper exercise price. Finally, the performance-related cash bonus will only paid if the company financial goals are reached next.

III. Conclusion

Taking Nike, Inc. as an example, this article mainly discuss about the compensation package of the top executive in a publicly listed company. The first section introduces the general situation of Nike including its product line, market situation, historical background and current chief executive officer. The analysis section can be divided into two parts. The first part describes the importance of a CEO in their company, agency problem, and the basic component of compensation package. The second part analyse the actual pay package of Parker, Mark and his competitor’s, then conclude a recommendations of new compensation package.

Compare with the existing compensation package, the new design pay more attention on stock options, in order to make it more reasonable and encourage CEOs to work hard and maximize the firm value. In my opinion, although there is no prefect incentives system, this kind of compensation may alleviate the agency problem more effectively.

Reference:

Alfred Rappaport (1999), New Thinking on How to Link Executive Pay with Performance.
Brealey, R.A., S.C. Myers and A.J. Marcus (2007) Fundamentals of Corporate Finance, 5th edition, McGraw-Hill, New York.
Brealey, R.A., S.C. Myers and F. Allen (2006) Corporate Finance, 8th edition. McGraw-Hill, New York.
Brealey, R.A. and S.C. Myers (2000) Principles of Corporate Finance, 7th edition, McGraw-Hill, New York.
Kevin J. Murphy (2000), Executive Compensation
Kevin J. Murphy and Martin J. Conyon (2000). The Prince and the Pauper? CEO Pay in the United States and United Kingdom. Economic Journal, Vol. 110, pp640-671
Sarah Skidmore (2010), Nike CEO Compensation Soars in fiscal 2010, http://www.kval.com/news/business/100080714.html, accessed on 5th august, 2010.

Table1:
Nike Compensation Table
|Name |Year |Salary |Stock Awards |Option Awards |Non-Equity |All Other |Total |
| | | | | |Incentive Plan |Compensation | |
| | | | | |Compensation | | |
|Packer, |2010 |$1,475,000 |$3,500,003 |$3,510,270 |$4,441,875 |$ 191,686 |$13,118,834 |
|Mark | | | | | | | |
| |2009 |$1,463,462 |$2,250,012 |$2,309,796 |$ 900,000 |$ 190,125 |$7,113,395 |
| |2008 |$1,376,923 |$1,500,043 |$1,872,315 |$2,682,684 |$ 188,687 |$7,620,652 |

Source:http://yahoo.brand.edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=7386788-114591-117822&SessionID=TgHoHqxOZW8Nl77

Table2:
Adidas CEO Total Compensation
| |Non-performance |Performance- |Compensation |Total |
| |related |related |component | |
| |compensation |compensation |with long-term | |
| |components |component |incentive effect | |
|Name |Year |Salary |Other |Performance |LTIP Bonus | |
| | | |benefits |Bonus |2009/2011 | |
|Herbert |2009 |€1,250,000 |€27,000 |€1,512,000 |€1,400,000 |€4,189,000 |
|Hainer | | | | | | |
| |2008 |€1,250,000 |€26,000 |€1,680,000 |€480,000 |€3,436,000 |

Source:http://www.adidas-group.com/en/investorrelations/corporate_governance/compensation_report/default.aspx

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