General Dynamics Slides

General Dynamics Slides - MECO 6303 Managerial Economics...

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1 Compensation Strategy General Dynamics March 5, 2011 MECO 6303 Managerial Economics
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2 Organizational Goal The organizational goal is to produce the goods and services demanded by customers at the lowest price while still covering costs. If you subscribe to the economic model of behavior , this requires that: decision rights be allocated in such a way that decision makers have the relevant specific knowledge to make good decisions; AND the incentive to use the knowledge to make value-enhancing decisions
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3 Organizational Architecture Organizational architecture is determined by a firm’s choice of: 1. assignment of decision rights centralization vs. decentralization how tasks are bundled into jobs 2. systems for evaluating individual and business unit performance determination of output to be measured subjective vs. objective measurement 3. methods of compensating and rewarding employees fixed vs. incentive compensation optimal risk sharing
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4 Three Essential Points No single organizational architecture is optimal for all times and circumstances. All three legs of the stool must be balanced and mutually supportive. If any one element of organizational architecture is changed, either one or both of the other two must also be changed. Theory is easy; applying it to real life is what’s difficult.
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5 Incentive Compensation Incentive compensation is any compensation contract--explicit or implicit--that rewards good (targeted) performance and/or penalizes bad performance. Forms include: piece rates and commissions performance bonus salary revision based on performance stock ownership and profit sharing promotions and titles for good performance dismissal for bad performance
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6 Economic Basis of Incentive Compensation 1. Personal welfare is maximized when the marginal (risk adjusted) benefit realized from performing or allocating time to any activity is equal to the marginal benefit from performing any alternative activity. 2. Effort is increased only when the marginal benefit of effort is increased. A fixed wage provides no incentive to work harder because it doesn’t affect the marginal benefit of effort. 3. In a competitive labor market, employees must be additionally compensated for bearing greater risk 4. Incentive compensation is required only to the extent that owners, managers and employees have different objectives (standard agency problem).
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7 Capital One CEO’s Option’s Play Wall St. Journal March 24, 2006 The Chairman and CEO of credit-card giant Capital One Financial Corp., whose pending takeover of North Fork Bancorp will trigger huge payoffs for executives of that New York regional bank, realized his own gain of $ 249.3 million by exercising stock options last year. In a proxy filing, Capital One, based in McLean, VA, said Richard D. Fairbank exercised options to
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General Dynamics Slides - MECO 6303 Managerial Economics...

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