Effective Regime of Executive Remuneration for Directors and Executives of Australian Companies - Research Paper Example

Table of contents Page Research ....................................................................................................... 2 2) Introduction........................................................................................................... 2 2.1. Research aims................................................................................................... 3 2.2. Hypothesis....................................................................................................... 3 3) Literature Review................................................................................................. 4 4) Research Methodology......................................................................................... 13 5) Conclusion............................................................................................................. 14 6) References............................................................................................................. 15 Explain how the interests of key stakeholders, including shareholders, should be taken into account in developing an effective regime of executive remuneration for directors and executives of Australian companies. Abstract The regulatory framework of executive remuneration in Australian companies basically depend on the regulated remuneration cycle which consists of four major activities – remuneration practice; disclosure of remuneration; engagement on remuneration; and voting on remuneration. Especially this cycle demonstrates the fact that the Australian remuneration practice is regulated by a good regulatory framework while the engagement of the shareholders is considered to be less regulated and mostly self-regulated by institutional investors whose interests extraneous in nature. Thus the Australian Government policy goals mainly depend on the remuneration practice, especially the engagement and voting activities of the companies. However this research proposal would demonstrate the shareholders’ interest on developing an effective executive remuneration regime for directors and executives and identify an effective remuneration regime in Australia which is needed for development and transparency of the remuneration process and practice in a causal contingency framework of convergence/divergence. Introduction Theoretical and conceptual frameworks on executive remuneration for directors of Australian companies and executives have been developed over the years to support efficiency hypothesis which invariably borders on the need to increase value of the firm in conformance with critical success factors. According to Chartered Secretaries Australia (CSA), directors and executive remuneration levels and structure have often been influenced by the existence of a variety of factors like community and political concerns, rules and regulations, code of practice and guidelines, market exchange rules and accounting standards. Under the section 9 of the Corporation Act defines remuneration of executive as “remuneration if and only if the benefit, were it received by a director of the corporation, would be remuneration of the director for the purposes of an accounting standard that deals with disclosure in companies’ financial reports of information about directors’ remuneration” (Australian Corporation & Securities Legislation, 2009). The remuneration to all the executives in an organization can be explained as the aggregate or sum of the payments receiving by all the executives including Directors, CEO, and Managers from a company or a corporation. Thus it consists of the normal payments to the executives such as basic salary, all incentives, bonus, shares and any other benefits such as allowances. Executive remuneration is a very important element of corporate governance and the level of benefits are determining by the board of directors. The determination of the level of the income of all these key individuals in accompany is a complex process to the directors because the company’s performance and the stability is highly depending on these individuals (Heracleous, 2001). Over the years due to the complexity of the work and the status remuneration receiving by executives has gone up rapidly when comparing to the normal workers salary. 2.1. Research aim The research aim of this study is basically determined by the ever increasing need to establish a framework for integration of stakeholders, including shareholders into the executive remuneration determination process with a greater degree of primacy and immediacy focused on the evolution of a convergent paradigm. In other words a paradigm of convergence rather than a contingency model for the incorporation of stakeholder interest into the existing executive remuneration determination process is much more desirable against the backdrop of Australia’s evolving scenario of directionless developments (Du Plessis, McConvill, & Bagaric, 2007). This research effort places emphasis on both institutional and regulatory contingency model building efforts thus identifying and isolating the most significant a priori implications arising from the implementation related constraints. Thus this paradigm would essentially seek to establish some positive and negative correlations between and among such primary and immediate variables as the leveraging freedom of the corporate manager and the equity holder’s relative power projection capability at Annual General Meetings. 2.2. Research Hypothesis Australia’s executive remuneration for directors and executives is lacking in the kind of systemic rule based homogeneity that both North American and European executive remuneration regimes process. Thus the a priori causal factors have received much less attention even in independent research works undertaken by scholars and as a result a dynamic and holistic framework of analysis based on empirical evidence is not altogether available right now. While the degree of regressive causation between autochthonous principles of remuneration related taxation and the legislation based legitimacy is quite obvious, neither the Australian authorities nor corporate establishments have made a convincing effort to regulate the executive remuneration regime in Australia on the lines of what obtains in North America and Japan where the existing corporate culture actively discourages such regressive causation (Anderson, Cavanagh, Collins, & Pizzigati, 2009). 3. Literature Review 3.1. How the interest of key stakeholders, including shareholders, should be taken into account in developing an effective regime of executive remuneration for directors and executives of Australian companies? (Appendix I) All stakeholders of the organization or in a corporation aim to receive more benefits from the business than they have invested in. Stakeholders include all the key individuals in a company such as board of directors, chief executive officers, general managers, lower level managers, shareholders and customers. Clarke (2004) identified that corporate stakeholder is an important party who can affect or be affected by the actions of business entirely. However stakeholders need not to be directly involved with the company as in the case of non-working directors. Every stakeholder would like to see the growth of the company and to maximize the profitability and sustainability and thus to maximize the remuneration and other benefits that they are entitled to receive from the company. And there is a regulatory protection available to all the executives in Australia according to the Australian Prudential Regulatory Authority (APRA) (www.apra.gov.au). The level of remuneration level to all stakeholders is governed by this body and thus it has laid down certain guidelines to be followed all Australian companies. The regulatory frame work regarding the remuneration includes adaptation of remuneration practice in companies, disclosure of remuneration policies and practices, engagement on remuneration, and voting on remuneration. Woldring (1995) described in his study that the Australian government also laid down certain policies and goals regarding remuneration to the executives to maximize the transparency, accountability and shareholder participation. The government passed Audit Reform and Corporate Disclosure Bill regarding this issue in the year 2003 in order to put in place a regulatory mechanism to ensure the maximum transparency in delivering remuneration packages to the executives. The aim is to bring into effect the type of remuneration based on the performance to the executives to avoid any disputes between the other parties in a company such as employees and the shareholders. In Australia, there are certain procedures regarding the remuneration packages to company executives. In a company shareholders can vote on the issues regarding the increase of payments to the stakeholders including board members, so the shareholders are given the powers to control the remuneration level of the stakeholders. As a result they can vote and can take the ultimate decision of expelling some of the board members of the company (Korac-Kakabadse, Kakabadse, & Kouzmin, 2001). Effective executive remuneration policy consists of three characteristics - design of the framework, decision process and disclosure of the policy to the external parties. As for the first all relevant parties responsible for the making of policies such as board of directors, chief executive officers, shareholders of the company and the managers of all levels will be gathered in a meeting and will decide on the matters. When all ideas are taken into consideration executives can design the framework for the remuneration system. The policy should be an effective one thus all the parties should agree on it. The framework for remuneration should be a long term policy and it should depend on performances of the executives derived from the sustainable facts. Thus the policy should clearly define the procedures of accounting to determine the additional benefits that executives will receive from the company. The policy that has been designed by the key individuals of the company should be disclosed to all other employees and stakeholders of the company. This enables the company to design and implement an effective regime for the executive’s remuneration with more transparency in policies. The second dimension is concerned with the decision making process; it includes procedures and the practices that the company has to adopt to successfully implement the guidelines laid down by the proposed regime. The process should be an independent one and there should be no room to interfere with the procedure by external influences. The independent process of remuneration should not give any opportunity to any executive to decide his or her own remuneration. The reliability and the effectiveness of the regime can be evaluated by frequent sufficient checks on the process and disclosing to the external parties. The process of deciding remuneration to the executives should be a balanced one and it should satisfy all the parties of the company. The third dimension is concerned with the disclosure of the policies and the practices to the external and internal parties. This process will enable the company to have a greater amount of transparency in fixing the remunerations for its executives. Thus the company can achieve external accountability of the company. This initiative will increase the confidence of the shareholders and therefore it will boost the company shares on the stock exchange because investors will be confident to invest through buying shares of the company due to the transparency of its stake holders regarding their remuneration receiving from the company. So investors may feel that the key individuals will not misuse their money and thus they will adapt to the difficulties arising due to lack of funds and may sacrifice voluntarily some of the benefits in monetary terms in the company’s interest. Disclosure of the information regarding remuneration policy of the company and its content, structure and performance criteria in annual accounts is a compulsory activity in Australia. According to the Australian Companies Act 2005 and the Code of Corporate Governance 2007 Revised Amendment, disclosure of such information in company’s annual reports is compulsory. By following these guidelines certain companies have disclosed about the remuneration package that the executives are receiving, in 2003 financial reports. Kiel & Nicholson (2003) commented that it is important to give the power to company’s shareholders to vote on the remuneration policy of the company at the general meetings. Shareholders can vote on the each director’s or executive’s level of income receiving from the company. This initiative further discloses each executive’s level of benefits and income derived from the company. So either shareholders can approve by voting on the issue or they can advise the company on the current situation and the impact of high remunerations to its executives. This attaches a greater degree of importance to the voting power of shareholders. Other benefits such as share option schemes also can be subject to some checks under the voting system. It’s better to go for prior approval to buy into share options as a remuneration related scheme to all the executives. The benefit of this would be that the process would increase the transparency in availing share options. Another important aspect of maximizing the transparency in executive’s remuneration packages is to separate the role of the Chief Executive Officer (CEO) and the Company Chairman’s role. Most of the companies have two officials to these positions and the Chairman also receives a huge remuneration package from the company. So it is important to separately identify the CEO’s role and Chairman’s role for the purpose of assessing the performance based remuneration to these two parties. Sometimes there are conflicts in companies with the Chairman misusing recourses of the shareholders due to the high salary and incentives he receives from the company. On the other hand the CEO is the person who introduces new initiatives in the company. His involvement in operations can produce successful outcomes. Obviously he is entitled to receive more benefits from the company in the form of combined remuneration. It is essential to disclose both the Chairman’s and CEO’s remuneration separately to the society. This type of disclosure process and transparency will enable the company to have external accountability and to have a positive image about the company in the eyes of the public. 3.2. The key regulatory agencies (Australian) which need to be involved in the development of the remuneration regime and justify their role in ensuring the effectiveness of the regime (Appendix II) According to the Productivity Commission (2009) the creation of Nomination, Formation of Audit Committees that are responsible for analysis and provision of advice regarding executive’s remuneration annually, will increase the flexibility of the process and also will enable the reconciliation and minimization of grievances regarding remuneration. For this purpose independent audit committee should be appointed by vote of shareholders. Reports should be published in order to maximize the transparency of the auditing process so as to give relevant facts about the company’s remuneration levels for all its executives. Thus the audit report will enable shareholders to discuss matters related to remuneration at a general meeting. Strong presence of the directors at board meetings will be a distinct advantage for discussions on matters relating to their remuneration and to have negotiations with shareholders of the company. This flexible procedure in improving the government standard regarding the executive’s remuneration is of very significance in the backdrop of what can be described as the Australian government’s desire to increase the level of transparency concerning executive pay. Majority of Australian company directors and executives are aware of the need for boards to “stress test” the accepted remuneration arrangements before agreeing to variations. Because this will enable the Australian companies to identify and understand the variations caused by the general economy and market circumstances and adjust to these conditions in order to fix the basic pay on the short term and long term based on incentives and thus consider the possibilities of basic pay and long /shot term incentive plans to be flexible with the economic recessions. Another suggestion by the directors to link incentives and benefits with a relevant set of performance measures is to enable them to promote the performances on a long term basis and wealth creation efforts of the organization. It is better that the company executives decide their own remuneration based on their own performance and by putting in more commitments in order to achieve long term success. The other fact is that the remuneration of the executives always needs not to be in monetary terms. They can get the shares and the rights other than cash as their remuneration. The executives have to adopt this method of remuneration when the company’s cash position is not good and when the general economy is undergoing a recession. Directors and the executives can terminate their additional bonus rights for the sake of the company. This shows the loyalty of the executives towards the company. Also it helps to boost employee morale. While the economic principle behind such remuneration regimes is basically the productivity enhancement there is also the motivation factor that such inducements as monetary and non-monetary benefits might not be able to bring about. Motivation and remuneration are considered to be more complex for most of the Australian companies and it can be regarded as the critical tool when it comes to the performance of the directors and executive in particular and employees in general. There is a direct relationship between the director and executive remuneration and in most of the large scale Australian companies using performance plans in order to provide incentives to its all levels of the employees is a well known device. Especially the stakeholders would determine the remuneration schemes for the directors, Chief Executive Officer (CEOs) and the other top executive in the organization (Hamilton, & Clarke, 1996). When shareholders determine the remuneration, it is necessary to concentrate on external information as well, e.g. competitor companies. It is basically determined by the capital structure of the firm because when the firm’s equity capital is greater than its debt capital managers holding executive positions with the sole power to determine their own pay would have less powers while when the firms debt capital is greater than its equity capital managers would have the power to decide on their pay related matters. In the former case stakeholders including shareholders would exercise great influence in deciding the level of remuneration of the executives of the firm while in the latter case they would have less influence. Remuneration strategies are nothing new in the modern work environment though, many of them might be lacking in those essentially significant aspects of performance paradigms and pay/benefit packages. However, the theoretical and conceptual frameworks of reference and analysis in this paper would seek to cover an adequate amount of current literature on the subject of remuneration strategy so that the paradigm shift in the Australian Company’s policy and strategic initiatives would cover a sizeable area of literature on the subject. Developing a better compensation strategy is crucial though sometimes it is regarded as a major challenge by the key shareholders of the modern Australian organizations due to different, uncontrollable external factors. Thus it is obvious that these external factors would affect the stakeholders and directors decisions at Australian companies to adopt different compensation policies and strategies. However there can be identified major three factors which would directly affect on compensation strategy of the modern Australian organizations, such as technology barriers, labor supply constraints and complex regulatory framework. Therefore compensation strategies must innovative to gain competitive advantages with the changing pressure in the external environmental factors. In the first instance, most of the Australian organizations need to run up against the technology barriers which prevent successful alignment of the organizational compensation strategies. Kirkpatrick (2009) argued that in today’s complex business environment, along with new behaviors and collaborations are necessary to integrate across the organizations functions. Yet its compensations strategy should aligned with those emerging needs of the external environment. Especially payment tools and incentive management programs which are using by the Australian companies is considerably inadequate to meet today’s demand of the directors and senior executives. Secondly, labor supply constraints would be directly impacted on Australian Company’s compensation policies and strategies of the directors and executives. Growth patterns in labour demand and supply have been highly characterized by a regional trend of change. Thus the labor market shortage, especially shortage of the skilled labor can be regarded as the major constraint in the Australian country in general and companies in particular. This is particularly obvious in respect of Australian companies operations with worldwide presence. Supply-side theory basically underscores the importance free mobility of labour, i.e. geographical and occupational. However when supply of labor increases labor supply constraints will be removed and it will affect on compensation strategy at Australian Companies. Thirdly, legislation framework in the Australian countries would affect compensation policies and strategies for directors and executives of the companies. Thus Australian Companies have set above average compensation policy for directors and executives in particular and the culturally diverse workforce in general and moreover it is the most comprehensive compensation package which is offering by the companies in the world. In order to achieve this goal the Australian government policy must be in alliance with far reaching reforms to health benefits & pension programs, labour markets and their structures. One of the hurdles to this efficient functioning of labour markets is the national minimum wage policy. Similarly another hurdle is the granting of unemployment benefits. These are common features in the national economy though Australian companies have successfully tackled some of the negative consequences arising from these government policies in labour markets. There are some key regulatory agencies in Australia which are involved in development of remuneration regimes in order to ensure the effectiveness of the Australian companies. ASX Corporate Governance Council can be identified as a diverse body which consists of 21 business, investment and shareholder groups (www.asx.com). Thus its mission is to develop a practical guide for the listed companies in Securities exchange Limited (ASX) and ensure a principle based framework for their investors and Australian community. Collett & Hrasky (2005) shows that ASX’s diverse membership and balanced regulatory approach under the corporate governance principles and recommendations provides non-prescriptive and principle-based framework for its listed companies. Thus the Australian companies require ensuring that remuneration for directors and executives should be both sufficient and reasonable. The ASX council proposes fair and responsible remuneration under the principle 8 and it indicated some recommendations as indicated below. Firstly, the board should have a remuneration committee. Thus it can be identified as an efficient mechanism in determining the suitable remuneration policy for the company. Thus it motivates senior executives in the company in order to drive them to the success and the long term survival of the company (Almazan, & Suarez, 2003). Secondly, the remuneration committee should be well structured, clearly sets of its roles and responsibilities, composition and so on. Therefore it should consist of more independent directors and chaired by an independent director. Thirdly, companies require to clearly differentiating the executive directors and executives remuneration against the non-executive director’s remuneration. Finally, companies should provide all the information which is required in the Guide. 4. Research Methodology This Methodology gives both a theoretical and conceptual outline first. Next it dwells on the practical aspects of the research methodology utilised to analyse the research data and describes the various methods used in this study. This research basically consists of both the primary and secondary data sets. Primary data set would consist of a questionnaire administered to 40 directors and executives working at public and private companies in Sydney Australia, including 20 directors and 20 senior executives. The questionnaire would be administered on a one-to-one basis. Secondary data would be collected through an extensive research effort conducted both online and in libraries. This research methodology mainly depends on the secondary data, basically due to the theoretical analysis is much well facilitated by it than primary data which is basically limited to responses in the questionnaire. The available literature has been analyzed with specific focus on the developing effective executive remuneration regime for directors and executives and how it positively impact on them and the end results of the company. This researcher has tried to show the most important aspectual overview of the research in the Literature Review. However the research methodology of this research places emphasis on both the qualitative aspect of it rather than the quantitative aspect. Conclusion Following conclusions are intended to drawn on a broader level on both theoretical and empirical analysis. However despite these claims still some glaring differences between what’s universally promised in the offers made to employees at the time of hiring and the real pay and benefits can be noticed at Australian companies. Though many of these principles were initially intended to help create an internationally competent workforce at Australian Company’s diverse units of service in the world, the evolving twin strategic environments of competition and corporate social responsibility (CSR) and the corporate governance compelled Australian Company to go back on some of the principles. The current compensation policies and programs as made available to new recruits promise job enlargement and enrichment related benefits that when translated into monetary terms mean quite a lot. The theoretical and conceptual framework of analysis and the contingency model of compensation strategy for its directors and executives at Australian companies are essentially characterized by the fact that they have been more oriented towards setting some international compensation standards for their directors and executives while satisfying the expectations of key stakeholders. References 1. Almazan, A & Suarez, J 2003, ‘Entrenchment and Severance Pay in Optimal Governance Structures’, Journal of Finance, vol. 58, pp. 519–48. 2. Anderson, A, Cavanagh, J, Collins, C & Pizzigati, S 2009, America’s Bailout Barons: Taxpayers, High Finance, and the CEO Pay Bubble, 16th Annual Executive Compensation Survey, Institute for Policy Studies, Washington, retrieved from http://www.bizethics.org/2009/09/executive-excess-2009-america%E2%80%99s-bailout-barons/ on May 22, 2010. 3. ASX Corporate Governance Council, retrieved from www.asx.com on May 22, 2010. 4. Australian prudential regulatory authority (APRA), retrieved from www.apra.gov.au on May 22, 2010. 5. Clarke, T (ed.) 2004, Theories of Corporate Governance: The Philosophical Foundations of Corporate Governance, Routledge, New York. 6. Collett, P & Hrasky, S 2005, ‘Voluntary Disclosure of Corporate Governance Practices by listed Australian Companies’, Corporate Governance, vol. 13, no. 2, pp. 188-196. 7. Definition of the executive remuneration, retrieved from Australian Corporation & Securities Legislation 2009, www.liv.asn.au on May 22, 2010. 8. Du Plessis, JJ, McConvill, J & Bagaric, M 2007, Principles of Contemporary Corporate Governance, Cambridge University Press, Cambridge. 9. Hamilton, L & Clarke, T 1996, ‘The stakeholder approach to the firm: a practical way forward or a rhetorical flourish?’, Career Development International, vol. 1, no. 2, pp. 39-41. 10. Heracleous, L 2001, ‘What is the impact of Corporate Governance on Organisational Performance?’, Corporate Governance, vol.9, no. 3. 11. Kiel, GC & Nicholson, GJ 2003, ‘Board Composition and Corporate Performance: how the Australian experience informs contrasting theories of corporate governance’, Corporate Governance, vol. 11, no. 3, pp. 189-205. 12. Kirkpatrick, G 2009, ‘The Corporate Governance Lessons from the Financial Crisis’, Financial Market Trends, OECD, retrieved from http://www.oecd.org/dataoecd/32/1/42229620.pdf on May 22, 2010. 13. Korac-Kakabadse, N, Kakabadse, AK, & Kouzmin, A 2001, ‘Board Governance and Company Performance: any correlations?’, Corporate Governance, vol. 1, no. 1, pp. 24-30. 14. Productivity Commission 2009, Executive Remuneration in Australia. Retrieved from http://www.pc.gov.au on May 22, 2010. 15. Woldring, K 1995, ‘The ethics of Australian executive remuneration packages’, Journal of Business Ethics, vol. 14, no. 11, pp. 937-947. Appendix I Figure 1: The Regulated Executive Remuneration Cycle Source: The Regulatory Framework for Executive Remuneration in Australia, Kym Sheehan. Appendix II Figure 2: The key regulatory agencies involved in the development of the remuneration regime Source: The Regulatory Framework for Executive Remuneration in Australia, Kym Sheehan. Read More