Corporate Governance and Executive Compensation - Essay Example

Corporate Governance Name Name of Institution Corporate Governance Introduction Corporate governance is a broad area that covers issues related to balancing the interests of internal and external stakeholders of a firm. This essay focuses on the issue of executive remuneration. The paper begins by describing the companies whose executive remuneration practices are assessed in a newspaper article. The next section describes the key arguments made by the author of the article. This is followed by a review of literature to examine the relationship between hefty compensation and firm performance. The essay then explains why the issue of executive remuneration is addressed in the media, followed by recommendations for the firms under review. Outline and Summary of Arguments Westfield, Amcor, and Caltex are among the largest listed firms in the Australian Stock Exchange. Westfield operates in the retail sector where it runs and franchises highly productive shopping centres. Amcor, on the other hand, is a listed firm that offers a wide array of packaging solutions to the beverage, healthcare, tobacco, food, and home and personal care industries. The third company that is under review is Caltex, a firm that specialises in refining and marketing oil as well as being a convenience retailer. Given that the three firms are listed on the Australian Stock exchange, they are expected to guard and advance the interests of the shareholders. One of the ways in which the interest of shareholders can be protected and advanced is through the remuneration practices at these businesses. In particular, executive compensation is a corporate governance issue that has to be addressed especially after the global financial crisis. The article “From Westfield to Caltex: Big Pay is back” by Sarah Danckert seeks to examine the issue of executive remuneration. The author notes Australian firms have attained levels of performance that were better than expected, but that Australia’s overall wage growth has fallen to record lows (Danckert 2016). Surprisingly, executive compensation in the three firms under review had risen to staggering levels that do not match with the overall wage trends in the economy. For instance, the top three executives at Westfield received $US32.1 million with much of it allocated to the chairman of the firm and his two sons who occupy executive positions in the firm. In addition to the massive amounts, there is the issue of whether the family members were the most talented individuals to run the business (Danckert 2016). When it comes to Amcor, the former CEO who retired in 2015 received a pay package that amounted to $US22 million. Similarly, Caltex’s CEO received $US13.86 million, but it is critical to note that the amount was attributed to an upswing in the firm’s profitability (Danckert 2016). As stated, these firms surpassed expectations which can help to explain the rises in executive compensation (Danckert 2016. However, there might be scenarios where executives set low expectations and then demand excessive compensation when they beat these expectations. In summary, the article raises issues on the importance of CEO’s to businesses and whether they are overpaid. Executive Compensation Corporate governance defines a system of managing and supervising corporate behaviour and balancing the interests of external stakeholders and internal stakeholders who can be affected by the conduct of the corporation. The rationale for corporate governance is that it allows firms to operate at the highest level of efficiency and profitability thereby furthering the interest of the shareholders (Du Plessis, Hargovan, & Bagaric 2010, p. 10). According to Brink (2011, p. 10), the Agency theory plays a pivotal role in corporate governance. The agency relationship defines a contract where one party engages another to perform services on their behalf with the contracted party being given decision-making authority (Brink 2011, p. 10). When it comes to listed firms, the shareholders give the executive management the authority to run the business with the aim of achieving set objectives such as profit maximization. It is notable that shareholders retain the right to vote on major issues like dividends, mergers, and acquisitions. It is also evident that managers cannot be trusted to handle all aspects of their jobs in the correct manner thereby creating the need for supervision that will ensure that the interests of the executives are aligned with those of the shareholders (Brink 2011). This applies to the issue of executive remuneration where managers are increasingly awarded stock options as opposed to cash payments to align their interests with those of shareholders. Despite the consensus on the structure of executive remuneration, there is considerable debate on the appropriate amounts that should be awarded and whether higher amounts lead to improved performance (Fels 2010, p. 77). A key step in addressing the issue of executive remuneration is determining the importance of high-level executives to corporations. It is acceptable that CEO’s reputation is often tied with that of the company and its products and services. This is especially relevant in the present world of the internet and social media as CEO’s get more attention than ever before. The implication of this is that the success of a global multinational firm can be considerably influenced by the reputation of the person who heads the firm. Apple presents a relevant example where the innovation and quality of products were tied to the reputation of Steve Jobs. The other critical role played by the CEO is his/her ability to work with the investors, customers, and communities. Additionally, the CEO has to provide leadership and set the company’s culture thereby determining the path that a business will take. These critical functions support the view that CEOs are highly skilled workers who are in a position to create wealth and work in the interest of shareholders. Having enumerated the importance of the CEO, it necessary to examine the relationship between high levels of executive remuneration and firm performance. There has been a long-standing assumption that the agency problem can be resolved through remuneration as well-paid executives are likely to work in the interest of shareholders (Jensen, Murphy, & Wruck 2004, p. 22). This statement is based on the notion that big pay provides a way of motivating and rewarding executives. There is also the view that there is a limited pool of talent and that high levels of remuneration are essential for firms to attract the best executives. The expectation from these assumptions is that firms will derive better performance in terms of returns on assets and earnings per share by issuing hefty compensation packages. However, there is conflicting research on whether big pay has a positive or negative impact on the performance of companies (Fels 2010, p. 76). Furthermore, there is also research that shows that there is neither a positive nor a negative link between executive remuneration and firm performance and efficiency (Filatotchev & Allcock 2010, p. 22). For instance, Azim & Subramanian (2013) studied executive remuneration in the four largest Australian firms during the global financial crisis. The finding was that there was no relationship between executive remuneration and firm performance before, during, and after the global financial crisis (Azim & Subramanian 2013, p. 49). The lack of consensus on the relationship between executive compensation and firm performance suggests that excessive pay does not always lead to the protection of the interests of shareholders. Hill and Yablon (2002, p. 294) detail some of the past collapses of firms like HIH Insurance Ltd. and One.Tel in Australia where high levels of compensation were evident. The recent collapse of global firms during the global financial crisis presents further evidence that excessive executive pay is not always beneficial. In these cases, shareholders lost vast amounts owing to the collapse of businesses while executives got to retain vast portions of their earnings. This evidence indicates that the agency problem cannot be resolved by awarding enormous packages to executive management. In addition to the corporate collapses, accounting scandals provide further examples as to why executive compensation is such a controversial topic. According to Brink (2011, p. 11), a key tenet of the agency theory is that managers cannot be trusted to handle the task of maximizing shareholder value. Corkery & Medarevic (2013, p. 2) also note that senior executives and managers can be tempted to eliminate barriers that inhibit their performance and the remuneration that they can receive. It is acceptable that skilled managers can exploit weaknesses in accounting systems. For instance, Danckert (2016) notes that the performance of 46% of the 132 listed in the ASX 300 surpassed expectations with just 28% failing to meet expectations. This might indicate weak accounting practices where executives set low targets and obtain hefty bonuses when they beat these targets. In this case, the presence of executive compensation worsens the agency problem instead of being a tool to resolve the agency problem. In light of these findings on executive compensation, the trend towards big pay that is detailed by Danckert is worrying. Surprisingly, executives are awarding themselves hefty packages during a period where the nation’s wage growth is reaching record lows (Mulligan 2016). Pash (2016) provides further evidence of the trend towards higher pay by noting that top CEOs of ASX listed firms get more than double the pay awarded to the second highest paid executive. On average, the top CEOs get $3.8 million while the average executives get $1.4 million (Pash 2016). When compared to the average worker, the average executive can earn 12 times more than the average worker with the ratio getting worse over the years (Gregg, Jewell, & Tonks 2012). According to Corkery & Medarevic (2013), there are strategies that can mitigate the increasing levels of executive compensation. An example is the “Say-on-pay” provision that gives shareholders the power to vote against pay recommendations that are deemed to be excessive (Corkery & Medarevic 2013, p. 1). Telstra and Qantas are examples of firms that have utilised this strategy to control executives and minimize cases of excessive pay. Other strategies that can work include tough rules on pay-disclosures (Corkery & Medarevic 2013, p. 13). Furthermore, shareholders can limit the compensation given to retiring executives as in the case of Amcor’s former CEO who received $US22 million (Danckert 2016). Why Executive Compensation is raised in the Media The topic of executive compensation is common in the media owing to the controversy around it. As stated, there is no conclusive evidence that suggests that firms derive better performance from awarding massive compensation packages. Despite this, firms continue to award millions to executives thereby fuelling debate in the media on whether it is ethical to issue such packages. The recent global financial crisis is another factor that explains why corporate governance is a common topic in the media. According to Corkery & Medarevic (2013, p. 3), the public tends to ignore the excesses of senior executives during happier financial periods. With the spread of the internet and the global financial crisis, the public and shareholders get swift access to information on managerial excesses. This fuels public debate that is then reflected in the media. It is also worth noting that the media plays a critical role in corporate governance as a whole. Its key functions include collecting, disseminating, and amplifying information (Liu & McConnell 2013, p. 1). Bednar (2012, p. 131) also notes that the media can act as a corporate governance mechanism that can resolve the agency problem. This critical role, therefore, explains why the media has highlighted the trend towards hefty executive remuneration. Conclusion In summary, it is clear that hefty compensation packages do not guarantee acceptable levels of performance. The collapse of multinational firms coupled with accounting scandals illustrate that high pay does not necessarily resolve the agency problem. In my opinion, the shareholders at Caltex, Westfield, and Amcor and other firms should demand the right to vote on executive remuneration. They should also demand a clear explanation of the criteria used to award such massive sums to a few individuals. Shareholders should also leverage traditional and social media as it is apparent that media can be a corporate governance mechanism that can prevent excessive remuneration and mitigate the agency problem. Finally, firms should design remuneration structures that are commensurate with the nature of the firm and its shareholders. References Azim, M. and Subramanian M.K. 2013. Global Financial Crisis, Directors' Remuneration and Performance: The BIG 4 Australian Banks. LAP Lambert Academic Publishing. Bednar, M.K., 2012. Watchdog or Lapdog? A behavioral view of the media as a corporate governance mechanism. Academy of Management Journal, 55(1), pp.131-150. Brink, A. 2011. Corporate Governance and Business Ethics. Springer Science & Business Media. Corkery, J. and Medarevic, S., 2013. Executive remuneration under scrutiny: The cutting edge of the 'shareholder spring'. Corporate Governance eJournal, p.1. Danckert, S. 2016. From Westfield to Caltex: Big Pay is Back. The Sydney Morning Herald. Viewed 16 March 2016 Du Plessis, J.J., Hargovan, A. and Bagaric, M., 2010. Principles of contemporary corporate governance. Cambridge University Press. Fels, A., 2010. Executive remuneration in Australia. Australian Accounting Review, 20(1), pp.76-82. Filatotchev, I. and Allcock, D., 2010. Corporate governance and executive remuneration: A contingency framework. The Academy of Management Perspectives, 24(1), pp.20-33. Gregg, P., Jewell, S. and Tonks, I., 2012. Executive pay and performance: did bankers’ bonuses cause the crisis? International Review of Finance, 12(1), pp.89-122. Hill, J. and Yablon, C.M., 2002. Corporate governance and executive remuneration: Rediscovering managerial positional conflict. University of New South Wales Law Journal, 25, p.294. Jensen, M.C., Murphy, K.J. and Wruck, E.G., 2004. Remuneration: Where we've been, how we got to here, what are the problems, and how to fix them. Harvard NOM Working Paper No. 04-28. Viewed 16 March 2016 Liu, B. and McConnell, J.J., 2013. The role of the media in corporate governance: Do the media influence managers' capital allocation decisions? Journal of Financial Economics, 110(1), pp.1-17. Mulligan, M. 2016. Wages growth slows to 18-year low. The Sydney Morning Herald. Viewed 17 Mar 2016 Pash, C. 2016. Australia's top CEOs get twice as much as the next highest paid executive. Business Insider Australia. Viewed 17 March 2016 Read More