Literature Review of Corporate Governance and Dividend Policy - Dissertation Example

?Literature Review of Corporate Governance and Dividend Policy (Is Managerial Remuneration Excessive Table of Contents Table of Contents 2 Introduction 3 Excessive Managerial Remuneration 4 Excessive Managerial Remuneration in the USA 4 Corporate Governance and Managerial Remuneration 11 Common Theme of Corporate Governance 11 Managerial Remuneration 12 Argument for External Regulation 13 Agency Theory 14 Dividend Policy 16 Conclusion 18 References 19 Bibliography 23 Introduction In the modern days, corporate governance has achieved significant importance in the western nations such as the USA and the UK. Corporate governance has reached a new height where its activities are the outcome of sustainable business processes. It intends to create long-term value for the investors and the stakeholders. There is growing concern about the excessive managerial remuneration which was highlighted because of recent financial recession. There is much anxiety about making the remuneration packages highly controlled and avoid unnecessary risk or encourage corporate insatiability. Thus, an effort has been made to offer a global synopsis of the emerging concern with respect to the excessive managerial remuneration. The USA and the UK have been the main victims, as these are the nations that had experienced highest delays in economic recovery and economic slowdown with regard to business mismanagement. One of the main reasons for this has been the high compensation to the managerial executives. In the global perspective, remuneration has been recognized by the G–20 countries and the ‘Financial Stability Forum’ has deemed for excessive managerial remuneration as a causative issue ensuing the international economic crisis (Mukherjee & Majumdar, 2007). Excessive Managerial Remuneration The global economy is confronting with an earning conflict because of excessive managerial remuneration in major enterprises throughout the world. To investigate on the perpetrators of economic recession, the high managerial pay and extreme risk taking activities were cited as prime suspects. Among the two issues, the managerial pay leads to the primary focus and incited many public as well as political outrages. For instance, the insurance major named AIG was nearly shattered because of bad business performance and abundant remuneration scales. It was seen that AIG had paid almost 165 million USD of bonus amount to 400 employees in London. In Wall Street, the bankers gave themselves almost 20 billion USD as bonus in the year 2008 even when the economy was decelerating down. The government also expended huge money to assist the financial institutions. It was alleged that this type of ignorance for the expenditure and the outcomes of the managers’ actions have generated the economic crisis. The ethnicity, customs, spawned managerial remuneration plan with incentive that promote the unnecessary risk taking had given light to the economic crisis. The laws and regulations along with corporate boards were highly criticized for autonomous management of organizations (Thompson, 2009). Excessive Managerial Remuneration in the USA Several reports stated that excessive managerial remuneration in the USA has taken overwhelming economic levy in American society and intimidated the control in corporate sector, government and nonprofit area and created volatility in the economy. It has been observed that average employees in the USA need to work hard for a whole year to generate one day’s salary of most of the CEOs listed in the Fortune 500’. The gap between the lowest and maximum salary was extending. This salary inequality has endangered the basis of the USA democracy, management, and produced situation for financial instability. According to the report of ‘United for a Fair Economy’ (UFE), the CEOs in the big companies get almost 10.8 million USD as total remuneration, which is 364 times higher compared to the average American employees. The amount excludes the cost of bonuses and stocks and if included the amount will increase to a certain extent. Thus, it can be seen that the managerial remuneration is not only excessive but also is related with reduction of other employees’ wages. The increasing surge of managerial payment had declined the wages to reimburse the bill for CEOs’ remuneration and bonuses. Though the wages of general employees had increased to 5.85 USD/hour in 2007, the amount is so little compared with the improvement of managerial pays which has increased by 450% over past decade (Anderson & Et. Al., 2007). The following graph will show the increase in the salaries of CEOs with contrast to the average employees in the year 2006: Source: (Anderson & Et. Al., 2007). High remuneration is always defended as a prize for exceptional performance, but actually the connection between remuneration and performance is falsehood. For example, the CEO of ‘Countrywide Financial’ was regarded as the sixth biggest remunerated CEO, and the calculated remuneration amount was 42.9 million USD in 2006. In the subsequent year, the company’s mortgage turned out to be at the highest level and it had also made major contribution towards the liquidity problem in the USA (Rheannon, 2007). According to Forbes Magazine, the ‘top 20 private equity hedge fund’ executives earned almost 657.5 million USD in the year 2006 which was 22,255 times larger compared to normal American employees. The following graph will show the disparity of managerial remuneration in comparison to other employees in 2006: Source: (Anderson & Et. Al., 2007). The US managerial executives always try to stay in front of the European managerial executives with respect to the remuneration. In Europe, the corporate executives take less remuneration compared to the executives in the USA. In many organizations, the high managerial remuneration resulted in loss of employment. For example, in Airbus, the managerial remuneration was almost 8.2 million USD where there were 10,000 losses in employment. In the year 2006, the European executives were remunerated 12.5 million USD which was only one- third of USA executives’ compensation, despite the fact that the sales of European companies were larger than the American counterparts. The following graph will describe the comparison between American and European remuneration: Source: (Anderson & Et. Al., 2007). There were certain arguments in the favor of excessive managerial remuneration. For example, a few people think that excessive remuneration is necessary to magnetize good administrative talent. High remuneration can retain the good management who normally ignore to stay for long-term in an organization. However, the extreme gaps between CEOs and other employees’ remuneration can impact on the self-esteem of employees and result in lower productivity. There were huge differences with respect to the managerial salaries in corporate sector and salaries in government sector. The highest salaried person in the government sector in the US i.e. the President of the USA, earns 400,000 USD in a year, while the average remuneration of CEOs’ was 10.8 million USD. The differences in corporate sector and government sector had developed disagreement of interest, dishonesty and deformed the democratic system. In the nonprofit division, there also exists excessive remuneration. The biggest US business leaders were remunerated almost 36.4 million USD which is 38 times extra compared to the highest remunerated leader in non–profit division (Rheannon, 2007). The excessive managerial compensation had affected the shareholders. The compensation level of CEOs was so large that it slashed the corporate incomes. The governmental bodies had been also criticized for approving these large remuneration packages (Rheannon, 2007). ‘Time’ had made a list of top 25 people who were responsible for the economic crisis which includes top managerial executives to the federal government executives as well as the previous President of the USA, George W. Bush. The first managerial executive in that list was Angelo Mozilo, whose remuneration was criticized by political parties. The second name was Phil Gramm, the Chairman of Senate Banking Committee. He made major contribution for credit non-payment swaps which had destroyed AIG [1] (Time, n.d.). The third name is Alan Greenspan, Chairman of Federal Reserve. He had brought the low interest rate in the year 2000 which is one of the foremost reasons for mortgage crisis [2] (Time, n.d.). Besides, the American people are also blamed for economic crisis as they had the habit for borrowing money. Luxury and wealthy lifestyle had negative influence on the USA economy. The money that was borrowed was 60% more compared to the earnings of people of the USA in the year 1982. By 2007, the percentage had become 130% [3] (Time, n.d.). Corporate Governance and Managerial Remuneration The collapses of economy along with fund of shareholders which was expended on the excessive managerial remuneration had raised the thought that managerial executives of large organizations are self centered and they do not consider or have little consideration about the future of the organization. The managerial executives at times take advantage of their position and fulfill their own interest rather than companies and stakeholders’ interest. Several examples prove this fact. For instance, Fannie Mae, a large insurance corporation in the USA had provided large remuneration to their managerial executives whereas the company’s business was not at standard level. Besides, the corporate scandal of Enron also describes the poor corporate governance (McConvill, 2005). The increasing distrust and suspicion towards managerial executives had emerged the requirement of new corporate governance preserved by regulation and governing instrument. The principal assumption for corporate governance is that external regulatory instrument can push the higher authorities to divert their interest to the company objectives rather than their own. Common Theme of Corporate Governance According to modern corporate governance, the fundamental goal of business is to increase the financial value of shareholder and use the organization’s resources effectively. An effective corporate governance formation knows that the board is liable for shareholders. It is planned to communicate the significance of fiduciary duty, honesty, accountability and transparency. Honesty is vital for capital market and financial stability. Accountability is the duty of the managerial executives and they are liable for their deeds. Accountability helps to make sure that organizations’ actions are controlled for preserving the interest of shareholders. Transparency is the right of shareholder to recognize the financial performance of an enterprise. It is important because it gives clear revelation of managerial remuneration and financial performance of a company (Lacera, 2009). Managerial Remuneration For controlling the remuneration, there must be compensation committee which looks for the overall remuneration structure of an organization and decides the appropriate compensation for managerial executives and employees. Major rules of this field comprises of: The total remuneration of all managerial executives must be revealed to shareholders, which contains complete exposure of fringe remuneration, retirement remuneration and fair price of that remuneration Besides calculating remuneration, the professionals of compensation committee must not have other affiliation with the organization and should be present at every compensation committee meeting In remuneration, the benchmarking must be ignored Remuneration based income should only comprise of operating income and income of pension plan must not be regarded for remuneration purposes There is need to display graph of CEO’s total compensation, with contrast to the organization’s yield to the shareholders, relationship among yearly bonus and organization’s earning per share, ratio of CEO’s total compensation with salary of average employee and the name of remuneration counselor hired by the compensation committee and management (Lacera, 2009) Management remuneration unavoidably fluctuates according to the organization. An appropriate remuneration package for managerial executives includes a cautious indomitable blend of long and short-term inducement. The remuneration package for managerial executives should be planned to develop an adequate degree of risk and prospect on business as well as individual performance. The structure of remuneration is directly connected with the interests of executives and shareholders. The compensation committee must ensure that the remuneration is proportional with the input they had made to the organization. A diverse mix of remuneration for board and managerial executives can foster the correct incentive and prevent narrow focus on particular issues of organizations’ businesses (Alcoa Inc, 2002). Argument for External Regulation There was an argument against the external regulation that the regulatory ideas are undesirable and over-responsive. Many people believe that the initiatives target towards small bad enterprises, but the main effect will be on penalizing several larger organizations that are successfully running the business, seeking to recover the economy and providing good dividends to the stakeholders. The argument says that majority of managerial executives are honest and possess praiseworthy virtues, and external legislation to accomplish good corporate governance is incompetent and unnecessary as the objective of external legislation can also be accomplished by internal corporate culture of any organization. An organization can line up with modern corporate governance goals. In case, the corporate governance alters the concentration and performs towards improvement of positive quality of organizations, there will be fewer requirements for external regulation because it is a burden for majority of good enterprises. The objective of modern corporate governance is to support the welfares of investors and stakeholders (McConvill, 2005). Agency Theory In the year 1976, Jensen and Meckling had originated agency association as an agreement where one party involves with other parties. The former party is called ‘principal’ and the latter is called ‘agent’. As a part of administration, the principal can hand over part of decision making power to the agent. In the original business field the shareholder in many organizations entrust part of or complete decision making power to the CEOs. The following figure shows the agency relationship between principals and agents. Source: (Aston, 2011). The difficulty in agency arises because of impracticality of flawlessly toning each possible activities of an agent whose decision can impact on the welfare of the principal. This theory argues that an agency association remains when the shareholders employ managers for taking decision about an organization. The main reason for difficulties is that managers do not completely perform for increasing the shareholder’s assets; instead they seek to protect their own desires and increase the organization’s growth. The agency expenditure occurs because of deviation of interests among shareholders and managers. It is the total of monitoring expenditure, bonding overheads and outstanding loss. The ‘Free Cash Flow’ theory assumes that there exists huge disagreement between top management and shareholders. These disagreements are particularly rigorous in companies where cash flow is huge. It is the remaining money after funding every project of an organization. If the upper management holds maximum cash and does not devote in profitable opportunities, they possibly will overspend the cash on certain projects whose net present value (NPV) is below zero. The higher liability can decrease the free cash flow and as a result organization’s worth will increase. The agency theory says that unless the appropriate corporate governance is put into practice the managers will not increase the return of shareholders in big organizations. Corporate governance inspires managers to increase the value of the companies than fulfilling their individual interests. Corporate governance deals with the methods where shareholders can comfort themselves for receiving good return on investment. Corporate Governance is required for managing agency problems created by the severance of shareholder and manager. There are several mechanisms for reducing the problems of agency which are remuneration agreement, clear and consistent financial information, legal protection, proprietorship structure and utilization of leverage and dividend policy (Yau, n.d.). Dividend Policy It is extensively accepted that agency problems are endured because of separation of proprietorship and control which affect the administrative decision procedure. The dividend policy is connected with free cash flow and managerial decision. It is the duty of corporate governance to make sure that managerial decisions are checked continuously and this can be accomplished by observing and reviewing the managers internally and directing the organization externally. The dividend can be used to make managers to return money to the investment market when there is high profit opportunity. The investment financier performs on the behalf of stockholders to watch on managers and guarantee sound corporate governance. Extravagant expenditure on unnecessary projects can have an effect on organizations and limit the growth prospects. Furthermore, high growing organizations pay lower dividend in nations with high safeguard. The shareholder’s right is related with dividend payout and organizations which confine the right are unable to evade the scrutiny in the industry. Corporate governance alleviates problems, observes management and affects agency expenditure and dividend payout. According to empirical model the dividend is calculated by following formula: Dividends i,t = ? + ?1Payoutsi,t + ?2 Governance i,t + ?3Organizationi,t + ?i,t Dividend is calculated as money paid divided by book value of properties. The ‘Payouts’ is the data for share repurchases to regulate other ways of money supply. The ‘Governance’ comprises of several corporate governance instruments (Bertus & Et. Al., n.d.). Conclusion In the light of economic recession, a developing agreement between legislators and industry contributors has taken place to apply corporate governance and regulation in the industry. Several companies concentrate on corporate governance instrument and many managerial executives have been forced by the consumers to incorporate corporate governance features in the portfolio management practices. It is universally acknowledged that strong corporate governance is necessary to mitigate the threat of managerial remuneration and controlling them. The corporate scandals of western countries such as the USA and the UK have led to the reevaluation of the principles and impose of financial regulation to business firms. The OECD codes decide key set of principles for corporate governance at global level. OECD codes have recognized that there is no solitary model for corporate governance (Cornford, 2004). The liberalization, economic growth, and globalization have brought about alterations in organized and legislative outline. Regulations can ensure clearness and impartiality in the managerial remuneration. Corporate governance can place much focus on the mechanism of every organization and increase disclosure system within organization. The successful application of corporate governance needs obligation on the part of corporations and their connections with investors, personnel, suppliers, regulators and stakeholders. References Aston, J. K., 2011. Agency Theory. What is the Corporate Governance Problem? Managerial Remuneration. Alcoa Inc, 2002. Principles of Corporate Governance. The Business Roundtable. [Online] Available at: http://www.alcoa.com/global/en/about_alcoa/corp_gov/pdfs/BRTPrinciples_CorpGov.pdf [Accessed August 31, 2011]. Anderson, S. & Et. Al., 2007. The Staggering Social Cost of U.S. Business Leadership. Executive Excess 2007. [Online] Available at: http://www.ips-dc.org/reports/070829-executiveexcess.pdf [Accessed August 31, 2011]. Bertus, M. & Et. Al., No Date. Sarbanes-Oxley, Corporate Governance, And Strategic Dividend Decisions. Auburn University. 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[3] Time, No Date. American Consumers. 25 People to Blame for the Financial Crisis. [Online] Available at: http://www.time.com/time/specials/packages/article/0,28804,1877351_1877350_1877319,00.html [Accessed August 31, 2011]. Yau, H. W., No Date. Case Study of Corporate Governance in Taiwan: Trends and Recommendations. National Taipei College of Business. [Online] Available at: http://www.google.co.in/url?sa=t&source=web&cd=9&ved=0CGQQFjAI&url=http%3A%2F%2Fibacnet.org%2Fbai2007%2Fproceedings%2FPapers%2F2007bai7521.doc&ei=D91cTqjnBY_irAfImtmbDw&usg=AFQjCNFzNwX1mh9Ow1csWBuNI5F1gJnVsw&sig2=XP-DC-e7n5Rq3bCVA3ZL3g [Accessed August 31, 2011]. Bibliography Hindery, L., 2008. Why We Need to Limit Executive Compensation. Bloomberg L.P. [Online] Available at: http://www.businessweek.com/managing/content/nov2008/ca2008114_493532.htm [Accessed August 31, 2011]. LaPlante, A., 2008. Excessive Executive Pay Makes Headlines, But So What. Stanford Graduate School of Business. 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