Corporate Governance Strategies - Case Study Example

Corporate Governance Strategies Table of Contents Background of the Study 3 a) Board of Directors 3 Role and Function 3 Addressing the Agency Problem4 Board Structure 5 b) Executive Pay 6 Executive Pay and the Agency Problem 6 Payment Structure of CEO 7 CEO Pay and Performance 7 c) Addressing the Agency Problem 8 Conclusion 9 Reference List 10 Background of the Study It is generally perceived that shareholders wealth maximization is the main objective of firms. However, in the process of maximizing the returns available to shareholders, the needs of the business are often left unfulfilled. This leads to a number of issues between the executives and the directors of a firm. To resolve such issues, organizations try to link the pay provided to the executives with the performance of the firm. However, this leads to empowering managers which may not be considered advantageous for the firm (Donaldson and Davis, 1991). The current paper analyses whether firms actually follow the shareholder wealth maximization concept and how agency issues are resolved. a) Board of Directors Role and Function The board of directors are the main developers of corporate governance policies in an organization. At Wolseley, directors commit themselves towards implementing ethical corporate governance framework. Accordingly based on the formal policies, the duties and functions of the board of directors are recognized to be as follows: Providing Continuity Board of directors (BOD) at Wolseley are liable to develop strategies that facilities the organization to continue operation for a long period of time. Hence, taking crucial long term decisions are a part of the major duties of directors. The board of directors are responsible to maintain continuity by ensuring that the company fulfils all legal requirements so as to continue functioning (Roberts, McNulty and Stiles, 2005). Chief Executive Appointment The directors are responsible for appointing CEO (Chief Executive Office). The CEO is responsible for carrying out the decisions taken by the board. The board is responsible to review the performance of the CEO regularly. The board is required to take decisions in respect to the appointment as well as termination of the executives. Governance The most important activity of the BOD is to frame ethical organizational policies that facilitate meeting the needs of all stakeholders of the organizations. The governance policies must be developed in a manner such that they lead to proper utilization of organizational resources. The BOD’s of Wolseley ensures that strategies formed provide the organization to realise their core values. BOD’s are required to ensure that high gains so that profits to shareholders are maximized (Carpenter and Sanders, 2002). Acquiring Resources BOD’s are responsible for acquiring suitable resources so that the organization can continue with their activities and also grow. Resources are acquired through purchases, mergers, acquisitions and many other strategies. Acquiring resources are a part of the long term decisions of the firm and thereby leads to lasting consequences. Hence, the responsibility of taking such crucial decisions lies in the hands of the BOD’s of Wolseley. The resources acquired determine how organizational activities are to be carried out. Ensuring Accountability Being the prime decision makers, BOD is responsible for providing adequate information to the external stakeholders of the organization which includes suppliers, business partners and shareholders. The directors are responsible for ensuring that suitable reports are prepared and provided to stakeholders so that they are able to understand the financial position of the company and take necessary decision in respect to investing in the firm. In this manner, the BOD influences the company’s image in the eyes of the stakeholders (Hutchinson and Gul, 2004). Addressing the Agency Problem The agency issue connected with the conflict of interests occurring between the managers and the owners. While shareholders of the organization seek maximization of returns available to them, managers seek organizational expansion and prosperity. These differential interests often lead to disparity between the BOD and the managers of a firm. Decision making often proves to be difficult due to such agency issues (Wasserman, 2006). Managers who act as representatives of the directors are required to carry out the decisions taken by the higher authorities. However, many at times, managers face the dilemma of meeting the needs of the directors as opposed to the needs of the organization. For instance, organizational expansion activities may lead to reducing the returns available to shareholders who are essentially also the directors of the organization. Directors try to influence the managers and executives by providing higher pay or by threatening them of being fired (Sanders and Carpenter, 2003). Therefore, Executives and managers often are left with no choice but to act in the best interests of the directors. However, in larger organizations, firms are required to ensure complete ethical compliance and their activities are often strictly monitored by external auditors to ensure that organizational activities are being carried out in the best interests of all stakeholders. External shareholders and employee unions pressurize directors to take decisions which are in the best interests of the organization as a whole (Bebchuk and Fried, 2005). Board Structure The board structure in respect of Wolseley is as follows (Wolseley, 2015): Changes in the BOD structure at Wolseley are as follows: (Source: Wolseley, 2015) Members appointed between the years 2012 to 2015: 1) 2013- Pilar López (Non Executive Director) 2) 2013- Alan Murray (Non Executive Director) 3) 2014- Darren Shapland (Non Executive Director) 4) 2014- John Daly (Non Executive Director) 5) 2014- Jacky Simmonds (Non Executive Director) 6) 2014- Michael Wareing CMG (Non Executive Director) The current board structure is deemed appropriate as it has undergone many replacements since the last three years. Such frequent replacements of the non executive directors facilitate in maintenance of skills and high performance of the board. It is observed that a significant number of members are young, possessing innovative skills to enhance organizational performance. Also, frequent change in the organizational membership leads to ensuring that there exists no discrimination in the board structure. This helps in reducing conflicts between the shareholders and the mangers of the company (Wolseley, 2015). b) Executive Pay Executive Pay and the Agency Problem Often executive pay packages are considered as a suitable solution to the agency problem. By providing executives with the adequate pay packages, the BOD is able to influence the management and the executive members so that conflict between the board and the executive members are low. Many firms are seen to solve the agency problem by providing equity or performance based pay. The executives’ compensation is determined on the basis of their performance. As a result, the compensation received by the executives gets associated with the firm performance. As firm’s performance enhances, the compensation received by managers and executives are enhanced (Burkart and Panunzi, 2006). Increase in firm performance leads to sufficient rise in the returns received by shareholders. Such a strategy is often stated to be the optimal contract approach. At Wolseley, the remuneration committee is seen to provide suitable framework for payment in respect of the executives. The business strategy of the company is seen to play an important role based on which remuneration is set. Hence, the performance based system is not followed by the company. By implementing the performance based pay systems, most companies empower management performance. If managers look after their own interests and do not strive towards enhancing firms returns, shareholders are also provided with lower pay. In order to avoid such a situation, Wolseley has not undertaken the performance based pay system (Wolseley, 2015). Payment Structure of CEO The payment structure for the CEO of Wolseley, Frank Roach is seen to be as follows: (Source: Wolseley, 2015) The on target pay and the maximum pay represent a percentage of the basic salary paid to the CEO. The salary of the CEO for the last two financial years was seen to be as follows: CEO 2014/15 2013/14 % increase F Roach £650,1631 £637,4152 2% (Source: Wolseley, 2015) The analysis reveals a 2% rise in the remuneration provided to the CEO. A major portion of the CEO’s pay includes the rewards and the evaluations carried out by the remuneration committee (Wolseley, 2015). CEO Pay and Performance There exists a major debate on the subject that whether CEO payment is linked with the firm’s performance. Many organizations try to influence the CEO performance by linking their payment to the firm’s performance. However, many organizations consider the same as a faulty technique as it leads to overpowering the executives and therefore avoid relying upon such policy. However, the performance based pay system is not completely avoided (Ortiz-Molina, 2007). Many organizations try to adopt a mixed policy where certain part of the compensation paid to the CEO is based on their performance, while, the remaining consists of fixed and rewards. Rewards and bonuses are set as per the board’s policies. Such a system of compensation has been adopted by Wolseley. Apart from establishing effective performance, executive pay strategies are also important for retaining important talent. Also, it is essential to consider that the CEO pay scale and the policies associated with the same are frequently revised. Linking performance with the pay provided to CEO is often done through providing stock options. Due to the pressure provided from the investors, organizations are often required to restrict providing stock options to the executives (Brown, Liang and Weisbenner, 2007). c) Addressing the Agency Problem In order to reduce the effects of the agency issue, Wolseley tries to align the needs of the shareholders with the needs of the organization. Long term strategies are planned by the company in a manner in which the firm profits remain high. This facilitates in providing high returns to shareholders as well as meeting the needs of the organization, management and other stakeholders. Wolseley is therefore seen to follow a combined technique, whereby, the needs of the company as well as the stakeholders are fulfilled together. The firm understands that in order to develop an ethical environment, the company is required to meet the needs of all stakeholders. Wolseley does not provide more than required power to executives. The directors try to maintain supreme control over the organization. The company identifies that maximizing shareholder wealth is crucial for achieving success. Hence, focusing upon the needs of the executives alone would not be deemed to be a satisfactory approach. Although, providing authority and advantages to the executives would influence them to perform better in the long run, relying upon executives completely for organizational development would not be considered as a successful strategy (Almazan, Hartzell and Starks, 2005). Wolseley therefore considers an ethical means to address the agency issue. The company well understands that mangers focus on increased pay and fulfilment of their own interests rather than maximizing shareholders wealth. To solve the issue, the company has partly linked the pay received by executives with the earnings available to shareholders. Hence, if the earnings rise, remuneration provided to executives also rise (W. S. Albrecht, C. C. Albrecht and C. O. Albrecht, 2004). Additionally, the company also identifies that managers and executives often vouch for the benefit of the company. This is also an essential component for organizational growth. For instance, managers may prefer to invest the revenues earned for innovation and growth related measures. This may however reduce the earnings available to shareholders (Wright, et al., 2002). Hence, in order to ensure that organizational needs are also met, the remuneration earned by executives is also linked with the growth of the firm as a whole. Therefore, executives are required to focus on not only maximising the earnings of the shareholders but also to enhance the profits earned before interests and taxes. Moreover, Wolseley does not try to influence executive opinions by providing them with higher pay. The judgements and actions of executives are independent and are solely guided by displaying high performance. Wolseley tries to implement a strong relationship with the management and the executives and consistently evaluate their performance. The internal governance polices and the consistent performance oriented pay policies lead the organization towards superior performance. Also, by frequently altering the composition of the board, the orientation towards seeking high performance rather than profits is further strengthened by Wolseley (Wolseley, 2015). Conclusion It is essential to understand that the disparity between managers and directors can never be fully reduced. The difference is interests are bound to give rise to issues. However Wolseley tries to reduce the issues by linking the earnings of both directors as well the executives with the performance of the firm. Rather than solely focusing upon the needs of the BOD or the executives, the firm tries to focus upon the needs of all stakeholders. Wolseley is a perfect example of how maintaining consistent all round organizational performance leads to increased shareholder wealth maximization as well as give effect to the growth of the organization. Reference List Albrecht, W. S., Albrecht, C. C. and Albrecht, C. O., 2004. Fraud and corporate executives: Agency, stewardship and broken trust. Journal of Forensic Accounting, 5(1), pp. 109-130. Almazan, A., Hartzell, J. C. and Starks, L. T., 2005. Active institutional shareholders and costs of monitoring: Evidence from executive compensation. Financial Management, 34(4), pp. 5-34. Bebchuk, L. A. and Fried, J. M., 2005. Pay without performance: Overview of the issues. Journal of Applied Corporate Finance, 17(4), pp. 8-23. Brown, J. R., Liang, N. and Weisbenner, S., 2007. Executive financial incentives and payout policy: Firm responses to the 2003 dividend tax cut. The Journal of Finance, 62(4), pp. 1935-1965. Burkart, M. and Panunzi, F., 2006. Agency conflicts, ownership concentration, and legal shareholder protection. Journal of Financial intermediation, 15(1), pp. 1-31. Carpenter, M. A. and Sanders, W. M., 2002. Top management team compensation: The missing link between CEO pay and firm performance? Strategic Management Journal, 23(4), pp. 367-375. Donaldson, L. and Davis, J. H., 1991. Stewardship theory or agency theory: CEO governance and shareholder returns. Australian Journal of management, 16(1), pp. 49-64. Hutchinson, M. and Gul, F. A., 2004. Investment opportunity set, corporate governance practices and firm performance. Journal of Corporate Finance, 10(4), pp. 595-614. Ortiz-Molina, H., 2007. Executive compensation and capital structure: The effects of convertible debt and straight debt on CEO pay. Journal of Accounting and Economics, 43(1), pp. 69-93. Roberts, J., McNulty, T. and Stiles, P., 2005. 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