Short-term and long-term Pay for Managerial Performance
The term ‘contingent compensation’ refers to the performance based compensation used for motivating the executives or managers of a business corporation for delivering superior performance. The pay for performance part of compensation package developed for executives can include short-term bonuses or long-term compensation such as stock options or stock bonuses. The short-term incentives compensation package consists of annual payments provided to executives on the basis of the company performance. The compensation committee developed by the Board holds the responsibility of creating the benchmarks of the company performance in specific categories such as earnings per share, return on assets or return on equity. Thus, the managers or executives are provided the bonuses if the corporate is able to achieve or exceed the benchmark. However, if the determined targets are not achieved then manger or executives are paid small or no bonuses (Stabile, 2002). Therefore, the pay to managers in such plans is contingent depend on the corporate achievement of the specified objectives. The long-term compensation of stock options refers to providing the option holder the right to purchase specific number of shares at a fixed price on the grant date whereas bonus stock is free stock that provides compensation to the managers irrespective of the rise or decrease in stock prices on the grant date. All these contingent compensation strategies are used by Board members for motivating them to deliver good performance and thus creative value for the shareholders. This si also ascertained on the basis of agency theory as per which strategic use of contingent pay improves the manger’s abilities and improved business outcomes as they places greater focus on improving the corporate performance (Yu, 2006).
However, there is also increased risk for manipulation of accounting information by the managers for increasing their pay for performance by depicting improved business outcomes. The business risk that is likely to be induced in the income depiction or stock returns of the corporations. The managers may adopt the use of unethical practices for improving the business performances or implement the use of fraudulent accounting practices for disclosing false financial information through its financial statements. The financial conditions of a firm has a direct impact on the stock prices and thus largely determine the long-term compensation of the managers. Thus, by using unethical business practices mangers may tend to disrupt the financial information for achieving their personal motives and thus creates risk for deceiving the investors or shareholders as they rely on financial information disclosed for making investment decisions.
Proportion of the CEO’s pay performance based and what proportion is not
In this context, it is essential for business organisations to implement strong corporate governance policies for balancing both risk and benefits for using contingent pay measures for managerial motivation. The remuneration committee developed by the Board should hold the responsibility of deciding an effective contingent pay measure that ensures minimum level of ethical risks. Also, the internal audit committee should review the compensation package of the executives or managers for identification of any unethical practices on the part of managers for fulfilling their personal interest. Also, the Board members should adopt the use of goal-setting theory for designing of contingent pay for executives. The compensation package should be directed to attain specific and understandable goals and compensation that are achievable and it should be structured properly to eliminate the possibility of occurrence of any fraudulent practices (Bloom and Milkovich, 2005).
2.Remueration Report for Woolworths Limited
(a)Short and long-term Pay for Managerial Performance
The short-term pay for performance for managers in Woolworths Limited consist of short-term incentives plan. The short-term pay for performance is determined on the basis of pre-determined targets achieved by the corporation on an annual basis. On the other hand, the long-term pay for performance is decided on the basis of long-term incentives that is divided on the basis of performance share plan and restricted share plan.
(b) Proportion of the CEO’s pay performance based and what proportion is not
75% of the CEO’s performance is performance based whereas the remaining proportion of the pay received by the CEO is no based on performance and is fixed.
(c)Measures of accounting performance are used to determine the CEO’s bonus
The CEO’s bonuses in Woolworths limited is determined on the basis of accounting measures of return on assets (ROA) and return on equity (ROE). These two accounting measures are based for determining the bonus payments in managerial compensation contracts (Woolworths Holdings Limited, 2017).
(d)Accounting decisions for CEO to maximise their bonus
The CEO might take the decision of increasing the financial leverage on the company fo r increasing the return on equity as long as the return on assets is greater than the after-tax cost of interest. However, it is ethical on the part of CEO for maximising the ROE to improve their bonus payments. The increase in return on equity would lead to improving the shareholder returns and at the same time increases the pay for performance of CEO. Thus, CEO might align their bonus plan as per the organisational strategy of creating value for shareholders as it would lead to the growth of the company as well as CEO (Zhang and Shalev, 2013).
Measures of accounting performance are used to determine the CEO’s bonus
(e)Use of Agency Theory To Provide Explanation to Various Remuneration Components
Agency theory is used to determine the relationship between the principals and agents. As such, the theory of agency seems to determine the variable components of remuneration in an accurate way. The principal are the shareholders whereas the agents are the managers or executives that act in the interests of the principals. The remuneration paid to the mangers or executives is the agency cost that is incurred by the shareholders. The shareholders seeks to reduce the agency cost whereas managers intend to maximise it. Therefore, the remuneration structure for the managers or executives should be decided in a way that aligns effectively with the interests of both the parties. As such, the contingent pay measures for managers should be determined by the Board that aligns with the interests of shareholders and maximise the performances of both the managers and shareholders (Yu, 2006).
- Safeguard the Bank Against The Risks Of Lending
The banks are required to carry out the valuation of any potential risk that can lead to the possibility of default on the part of borrower on its loan obligations. The banks on the basis of careful analysis and evaluation should take the decision regarding the issue of loan and determine the necessary conditions to be met in loan agreement for reducing the credit risk (International Financial Law Review, 2003). This is because banks are exposed to high risk of facing non-performing loans that can turn onto bad debt in the condition of economic downturn. The debt covenants are regarded as statements in the loan agreement that puts restrictions on borrowers for carrying out specific things. In this context, restrictive covenants puts restrictions on the assets of a borrower that is creation of any further changes on assets or sale of fixed assets. On the other hand, there are positive covenants that does not places any restrictions but imposes additional task for the borrowers. This includes submission of financial statements and securing the debt payment by maintenance of sinking fund. The agency problem may occur at the bank due to occurrence of conflict of interest between the bank managers and the federal banks related with the terms and conditions of the loan agreement. The accounting information proves to be highly critical for the bank managers to assess the risk related with providing the financial loans. This involves examination of the publicly available accounting information on potential borrower for identifying the credit rating and take decisions on the basis of the credit history of the potential borrower (Rugger, 2018).
References
Bloom, M. C. and Milkovich, G. T. 2005. The relationship between risk, performance-based pay, and organizational performance. School of Industrial and Labor Relations.
International Financial Law Review. 2003. How banks can reduce the risks of bad loans. [Online]. Available at: https://www.iflr.com/Article/2026910/How-banks-can-reduce-the-risks-of-bad-loans.html [Accessed on: 1 June 2018].
Rugger, D. 2018. The Bank Lending Process. International Journal of Business and Management 13(2), pp. 53-64.
Stabile, S.J. 2002. Motivating executives: does performance-based compensation positively affect managerial performance? Journal of Labor And Employment Law 2(2), pp. 227-285.
Woolworths Holdings Limited. 2017. Remuneration Report. [Online]. Available at: https://www.woolworthsholdings.co.za/wp-content/uploads/2017/12/WHL_REMUNERATION_REPORT_2017.pdf [Accessed on: 1 June 2018].
Yu, G. 2006. The Regulation of Executive Compensation: An Agency Perspective. [Online]. Available at: https://www.clta.edu.au/professional/papers/conference2006/2006GY_REC.pdf [Accessed on: 1 June 2018].
Zhang, I. and Shalev, R. 2013. CEO Compensation and Fair Value Accounting. Corporate Governance and Financial Regulation.
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