MSc Corporate
Governance
London South Bank University
Corporate Governance Principles and Practice
PRINCIPLES
FOR TOP EXECUTIVES REMUNERATIONS
AND
CRITICS ON PERVERSES INCENTIVES
Lecturer: Prof. Andrew Chambers
Fara Chorfi - 3101102
TABLE
OF CONTENT
I. Definition of an executive........................................................................................ 3
A. Principles of remunerations of Executives............................................................................... 3
B. Definition on Corporate Governance........................................................................................... 5
II. Perverse effects of the system and critics........................................................... 6
III. Conclusion................................................................................................................. 9
IV. Annex........................................................................................................................ 10
I.
Definition of an executive
According
Professor Chambers, an executive director is in effect an employee of the
company and it is appropriate that the terms and conditions of his or her
appointment should be set out in a written contract of service between the
director and the company[1].
The specific
contract of services for an executive director normally includes the following
conditions and terms, which includes among others conditions the involvement
and commitment as well as detailed benefit.
Popular definition of an Executive Directors refers to implement strategic
and operational activities of a company. They are in-charge and responsible for
the daily affairs of the business of the company. These include managing
committees and staff and developing business plans in association with the
board for the future of the company.
The role of Executive Directors is to design, develop and implement
strategic plans, in a cost-effective and time-efficient manner. Executive
Directors provide leadership and often fulfill a motivational role in addition
to office-based work. Executive Directors lead rather than just
manage the organization and develop its organizational culture[2].
A.
Principles
of remunerations of Executives
Executive directors receive remuneration in
the form of financial compensation. This includes a
mixture of salary, bonuses, allowances, perks, benefits, shares of and/or call
options on the company shares, etc... [3]
In a listed company the remuneration committee would
always have responsibility for advising the board on the remuneration of the
executive directors in all its forms, and would also frequently provide similar
advice with regard to the most seniors executives who are not board members[4]. The purpose of the Committee is to ensure that
the group of directors and senior executives are suitably motivated and fairly
rewarded for their individual contributions to overall performance. The
committee also demonstrate that the remuneration of the executive directors who
have no personal interest in the outcome of their decisions and who will give
due regards to the interests of the shareholders and to the financial and
commercial needs of the group.
Taking into account their role and influence in the
company and the linked remuneration, executive remuneration is an important
part of corporate governance.
Historically, the principle of remuneration changes as
for example, during the 1970s; the remuneration of any employees including
directors was calculated on basis of fixed remuneration. This situation was the results of a banking
crisis and at that time, directors and intelligentsia have spent much more time
to avoid taxes than to really perform for the best interest for the company. At
that time the highest tax rate applied to the top slice of remuneration raised
up to 83%. The tax condition changes a little bit during the Ted Heath’s
government. The changes begin with the first election of Madam Margaret
Thatcher with a reduction of the tax from 83 to 60% and introduction of
incentive plan to motivate management. From the year 84, a radical change of
approach in income can be considered as the starting point of the current
situation with the removal tax on share option, the 30% tax maximum on the
capital gain[5]. Over the past three decades, executive
remuneration has risen dramatically and nowadays, it has been stated that
salaries make up on average only 15 % of the total remuneration of the
executive directors of the ten largest listed companies in the United Kingdom.
According to principles of the code
provisions in relation to remuneration Policy [6],
the levels of remuneration should be sufficient to attract and motivate the executive directors in order to provide the
company with their professional commitment, which in turn should result in sustainable
growth of the company. Although, the interpretation of this principle implies
that companies should avoid paying more than what is necessary; it must provide
fair compensation for this purpose.
A proportion of the executive
directors’ compensation package should be designed in a way that it links
rewards to company and individual performance. The provision also includes rules
in relation to procedures to avoid potential conflict of interest. Such code provides formal and transparent regulations
to companies for developing policy on executive remuneration and for fixing the
remuneration packages of each individual director. Executive directors should not
be involved in deciding respective remuneration packages. [7]
This principle means that no director can interfere in salary’s decisions that
constitute a major difference from the past.
Art B.3 of the code states the
principle of full disclosure of remuneration in a way that the company’s annual
report should contain a specific statement of remuneration policy and details
of the remuneration of each executive director.
The UK corporate governance code
(UKCGC) has replaced the combined code for financial years beginning on or
after 29 June 2010.
The main concerns of the Financial
Reporting Council (FRS) and the purpose
of the new version of the UK corporate governance code is to provide principles
that facilitate “effective/efficient” management
that can deliver the long-term success of the company[8].
The general spirit of the new code is
to encourage a greater focus on board behavior and the FRS is concerned that the
executives should not be encouraged to take risks that leads to personal
benefits at the expense of the long term survival and growth of the company.[9]
Accordingly, the regulation of the
code concerns directors of FTSE 350 companies, which are now subject to annual
election; non-executives’ should not receive “performance related” benefits and
perquisites.
The remuneration in most cases
comprises of basic fixed salary depending on individual experience, potential,
performance, job size and scope plus comparison with remuneration in similar industry
companies.
Plus incentive plan, normally linked
to stretching target of Financial and non financial measures, significant
proportion of total package is related to performance
Significant proportion of total
package is in shares to align the interests of director’s executives with those
of shareholders’ (art B.1.4 code)[10]
B.
Definition on Corporate Governance
Corporate governance can be split
between what must be done, what is good practice and what organizations think
is good practice[11].
The common law principle proposed by
the Commonwealth Association for Corporate Governance ( CACG) in his draft of the “ten directorial duties” based
on long established corporate governance values, three mains principles as
guideline:
- Accountability
- Probity
- Transparency [12]
The main concerned stakeholders by
such stability on a long-term basis are mainly the owner/shareholders of the
company and, consequently, remuneration of the executives who run the business
for them, are an issue.
It is the shareholders who are
supposed to ultimately approve the remuneration of the directors; however small
shareholders rarely influence the voting results.[13]
In contrary, representatives of large shareholder
groups, as for example, insurance companies or institutional fund representatives,
usually issue their own guidelines on remuneration.
II.
Perverse effects of the system and critics
Nevertheless and unfortunately such incentive
models can become malign. As
demonstrated in the case of Enron, where the very efficiency with which incentive
contracts drove managerial behavior; resulted in destructive effects against
the interest of the company because the executives’ share-option models of
remuneration, led to powerful managerial incentives to distort disclosure.[14]
Corporate Governance and executive remuneration is currently a
debate between principal and agent and arise the question of the power of the
directors in the following manner: “Do directors have too much power? Such
debate concerning the ‘principal-agent’ issue, specifically who really is in
charge of top-level corporate affairs - directors or shareholders?
At the heart of the ‘divorce of ownership from control’ debate has
been the interference that directors (as agents appointed to act on behalf of
the shareholders) may have objectives, which may differ from those of their
shareholders (as principals).
Specifically, it has been emphasized that executives although
servants of the shareholders are likely to be more concerned with their own
rewards than explicitly working towards maximizing shareholder returns[15].
This performance objective
has sometimes been miss-interpreted in such a way that executives have pursued mainly their
own financial rewards against the survival/stability of the company, which led
them to fall in the manipulation of the Financial reporting, within the letter
of the law and accounting standard, but against its spirit and certainly not
with view to provide « true and fair » view of accounts.
There were many scandals
in relation with such “creative accounts and issues” as for examples[16]
- Is has been the case of the company Bristol-
Meyers: With objective to inflate the profit figures e.g. (Bristol-Meyers
Squibb, Inflated its 2001 revenue by USD 1.5 billion by
'channel stuffing', or forcing wholesalers to accept more inventory than they
can sell to get it off the manufacturers books [17]
For similar reasons and in
order to boost incentives, typical creative accounting tricks include off
balance sheet financing, over optimistic. Such off balance are of course
non-prudent and not realizable revenue recognition and the use of exaggerated non-recurring
or one off items.
- It has been the case of
the company Halliburton that has been improperly booked $100 million in annual
construction cost overruns before customers agreed to pay them. Legal watchdog
group judicial Watch filed an accounting lawsuit against Halliburton and its
former CEO, Vice President Dick Cheney, among others [18]
On the financial
vocabulary, the term « window dressing » has been used to describe
the manipulation of investment portfolio performance numbers.
In
most cases, beneficiaries of window dressing are those who use this practice
for their personal advantages, as for examples, companies and mutual fund
managers.
Also
in many cases, managers’ remuneration (as for examples salaries and bonuses
depend on how well their companies or mutual funds performed and this is the
main issues why there is a direct interest in making financial results or
liquidity look better than what they really are.
Those
techniques of calculation can include moreover, big bad accounting which means
one off restructuring charges in order to give a hidden reserve for future
exploitation in smoothing profit as well as what is called cooking jar
reserves, which is a way of creating reserve to be used in future loss-making
periods by over providing for future warranty costs or sales returns in
profitable periods,
The
financial technique of recognizing revenues in advance by incorporating an item
as revenue before appropriate is also used as well as the technique of
deferring/delaying necessary expenditure and maintenance expenses (as for
example the current situation of the London tubes) thus improving short-term
results by damaging the medium to long-term viability of the company.
The
principal motivation and issues for such creative accounting is the desire of
the executives to exceed market expectations and the fact that management
remunerations is directly related to the results of the company in financial
terms.
The
issue of such contraction raised directly the question of remuneration policy
because of the conflict between the payments of the bonus calculated on annual
basis against the long-term sustainability management of the company.
The financial
crisis has now opened a breach in the context of executive
compensation.
The reform of executive pay structures
within major financial institutions has been a recurring theme of the
financial-crisis-related reform movement.
The Financial Stability Board, the G20
group, the Obama Administration, the European Commission and the UK Financial
Services Authority have all highlighted the question of executive pay in
financial institutions in their responses to the financial crisis.
Currently, the international reform agenda
is focused on, among other things, the link between executive pay and optimal
risk management in financial institutions and on how remuneration “can be used to align managers’ interests with
a range of stakeholder interests, including those of governments as
shareholders/stakeholders in state-funded bank[19]
The transparency is a necessity on
good corporate governance, but there is also a necessity to regulate ethically on
reasonable return on time and intelligence investment for those who start to
become richer than the owner/shareholders of the property without investment on
capital and no serious personal liabilities.
As it has been stated in the financial
time: “There is a big gap between the professions;
the risk and the return on remuneration but
become richer than the owner of the property is a non-sense and still the open
question to be solved”.[20]
Shareholders of BP have pointed out
this mismanagement and non-sustainable issues after the accident in Alaska.
During an extraordinary meeting, part of the shareholders, demands more
implications and involvement and vote on the remuneration policy and directly
refer to the risk management decision which impact the reputation and return on
their investment.
Henry David Thoreau made an
interesting observation: “ It is true enough said that a corporation has no
conscience. But a corporation of conscientious men is a corporation with a
conscience”.
[1] Corporate Governance Handbook, Professor A. Chambers,
p 564
[2] Wikipedia.org/executive-director
[3] Corporate Governance Handbook, Professor A. Chambers,
C.5.50
[4] Corporate Governance Handbook, Professor A. Chambers,
p 1244
[5] Corporate governance Handbook, A. Chambers, p 527
[6] art B 1.1 to B1.6 of the UKCGC - Lecturer D.
Oakes, Financial Reporting, LSBU
[7] Lecturer D. Oakes (article B.2.1 up to B.2.6)
( J.sainsbury plc
annual report and Financial statements 2011, p 38 to 47).
[8] CO3 introduction
[9] Travers Smith, employée Incentives, December 2010
[10] Ifrs 2
[12] CACG, Corporate Governance Handbook, p. 1067
Long-Term Incentive Schemes, Executive Remuneration and Corporate Performance
Christopher Pass Working Paper No 02/15 July 2002
The
Corporate Scandal Sheet, enclosed paperEuropean Commission. European Anti-Fraud Office, OLAF Anti-Fraud Communicators Network - 2009 - 428 pages – Extracts
Please see enclosed the Corporate scandal sheet
Commission Recommendation Complementing Recommendations 2004/913/EC and 2005/162 (C(2009) 3177) (the 2009 Pay Recommendation) and Commission Recommendation on Remuneration Policies in the Financial Sector (C(2009) 3159) (the 2009 Financial Institution Pay Recommendation). In July 2009 the Commission also proposed pay-related reforms (SEC(2009) 974 and 975) to the Capital Requirements Directive (Directive 2006/48/EC [2006] OJ L177/1 and Directive 2006/49/EC [2006] OJ L177/201)
[20] Top executives’ pay rises 27-fold since 1988, Financial time, Dec. 12,
2011, By Brian Groom,
Business and Employment Editor
