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Unformatted text preview: t under control of the manager. This raises question on how one
can argue for bond price as the performance indicator of the manager.
Credit rating not controlled by managers: As already mentioned that one means of linking debt
is to link the bonuses with firm’s credit rating or credit default spread. But managers can only
control firm’s risk level, not the credit rating of their firm. So it is unfair to link the performance
based compensation with something which is beyond their control.
Linking the compensation with credit default spread as has been proposed by Columbia Business
School Professor Patrick Bolton will also have similar kind of issue. CDS is also a market driven
instrument, not under control of managers. 5. Equity or Debt? The following figures compare the compensation schemes under the two options discussed above. Figure 3: Equity Linked Compensation Evaluation 9 | P a g e Figure 4: Debt or (D + E) Linked Compensation Evaluation We considered the four basic parameters discussed at the beginning of our study. Neither equity,
nor the debt based compensation exactly replicates the performance of the executive or in other
words the firm value. But the comparison of figure 4 and 5 reveals that the debt based compensation
is better in terms of safeguarding lender’s incentive. An even better approach is to combine both
debt and equity in the package which will also give result similar to fig. 5. But this does not mean
that equal proportion of debt and equity is the cure for all. For a growth firm or a new firm the
equity component should be more and in case of a firm with high leverage the debt component
should have higher importance. 6. Conclusion As our discussion suggests neither debt nor equity has truly been able to satisfy all the conditions
required to frame an accurate compensation package. A better approach can be to link the
compensation with the performance matrix which managers can control. The performance matrix
should also consider broa...
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This document was uploaded on 01/14/2014.
- Winter '14