Chapter 11 Case Study

Building an Executive Compensation Package

The executives at Safeguard Insurance are focused on continuing efforts that have brought the company significant growth in the past 15 years. Director of Human Resources Beth Frazier is considering how to provide more incentives to executives to continue this focus. Two years ago, the company went public and began selling shares of stock on the stock market. While executives were granted some stock in the companys initial public offering, Beth now wants to examine the best way to use the companys stock value in the executive compensation plan. She knows that company ownership can help incentivize executives to increase the value of the company stock, and thus the ongoing success of the company.

Safeguard Insurance is led by an executive team that includes the chief executive officer, the chief operating officer, and functional area leaders, including chief legal counsel, the director of finance, the director of operations, the director of marketing and sales, and Beths position. There are also leaders within the different lines of business, including the director of personal lines insurance and the director of commercial lines insurance. Beth is working with the companys board of directors to examine the compensation structure of this team of leaders. In addition to a retirement plan and other basic benefits such as time off, the company offers a competitive base salary plus a bonus plan that is tied to company revenue. Beth believes that a more direct tie to the companys stock value may add just the right incentive for executives.

Since the companys stock went public, its value has been a key indicator of the overall success of the company. As the company executives are closely monitoring the company stock value, Beth believes that tying executive compensation to the stock value will provide a clear incentive for executives. If executives remain focused on increasing the overall value of the stock, they should make decisions that are in the best interest of the company. Further, both executives and the company will benefit if the value of the stock continues to increase.

Initially, Beth thought granting the executives annual incentive stock options would create the right incentive for the team. By doing so, the company would grant the executives the option to purchase stock later at the price on the date of the grant. The executives would then have an incentive to grow the stock value over time. However, a member of the board of directors suggested considering offering a phantom stock plan instead. A phantom stock plan exists when executives are compensated with hypothetical company shares rather than actual shares of company stock. Upon meeting certain conditions, executives receive income that is equal to the increase in the value of the company stock from the date that the phantom stock was granted until the conversion date.

Beth needs to conduct more research on both types of plans to formulate a recommendation for an incentive plan for executives. She must first decide if an incentive plan tied to the value of company stock is a good alternative for the company. It seems that this is a logical move to make, but Beth also needs to determine the best way to structure the plan. She thinks that the phantom stock plan may offer some advantages, but as she starts her research, she knows she needs to consider all the options.

Questions:

• 11-6. How does a stock option plan provide an incentive for executives?
• 11-7. Which plan would be better for Safeguard Insurance, the incentive stock option plan or the phantom stock plan?