Discuss about the Effect of Corporate Governance on CEO Pay-Risk.
The study intends to elucidate the evaluation of executive’s performance and remuneration in public listed companies in Australia. The main purpose of conducting analysis of the remuneration framework of company is to determine the effectiveness of control system by drawing attention toward reward system and performance of executives. For the evaluation of effectiveness of remuneration, the study has incorporated discussion on the review of literature regarding methods that are used for computing the performance pay. This particular paper has contributed to literature research by way of providing much needed evidence on importance of disclosure of remuneration that has been made mandatory and the explicit and formal disclosure requirement has also been released. Secondly, it has also contributed in general to literature related to disclosure. Furthermore, the analysis of annual report of chosen company is done for evaluation the remuneration framework and structure. The company that have been selected for conducting the research on annual report for this assignment is Qantas Airlines. Qantas airlines are the largest airline company operating in Australia in terms of international destination, international flights and fleet size. Some of the segments of company involve Qantas freight, Qantas flight, Qantas loyalty, Qantas domestic, Qantas international and corporate (Qantas.com.au 2018). The main operation of company is in domestic and international services of air transportation and freight services provisions in frequent flyers.
The nature and level of remuneration payments to executives in Australia has always been a newsworthy issue for regulators, investors and financial press. Companies were required to provide with a detailed disclosure of executive remuneration with the fiscal year ending on or after July 1998.
This particular section of study depicts the analysis of review of literature on the methods used for computation of performance pay. Discussion also incorporates position and guideline of Australian shareholder association on the remuneration of executive.
There is a literature body that is increasingly seeking to identify the relationship between system of human resource management and strategy of organization. It depicts how the performance of organization is enhanced by the practices of human resources. There are different approached used for paying for employees performance that will have considerable impact on organizational and individual behaviour. The organizational context forms the basis of determination of pay for performance system. Making payment for individual performance involves two common approaches. The popularity of incentive pay is declining and on other hand, the popularity of merit salary is increasing.
Incentive pay- The plans of incentives are based on making bonus payment to employees depending upon the number of units that are produced by them. This method is perhaps the most direct way that is used for relating pay to performance and it is evident from literature that incentive payment would motivate the individual behaviour. This is so because such plans help in selecting and attracting good performers as they end up being paid more. A detailed description is provided in the literature on pay incentive plans of the counterproductive behaviours that is produced by piece rate incentive plans. However, this kind of issue arises when service personnel and sales are put on incentive pay. In many respects, such concepts are not the only reason for the occurrence of such behaviours. Nevertheless, on the general idea of incentive payment, it is difficult to create distinction between particular plans and practical problems.
The incentive plans are associated with some problems such as beating the system, divided workforce, cost of maintenance, and culture of organization and incentive plan of small groups. Incentive pay is regarded as mixed blessings although it generates has various drawbacks associated with it. This particular approach is not implemented by many organizations because the performance increase by performance incentives is outweighed by cost of maintenance and negative effects of the plan. Sometimes, incentive pay is regarded as best fit for organization in situation where work is designed for individuals and is repetitive, simple and can be measured comprehensively. This particular plan helps in differentiating for creating small or isolated groups when competing with one another. Furthermore, it is associated with the control approach to management and its is perceived that incentive plan can be more effective if there is more involvement oriented management style that stresses due process, fairness and participation incentive pay (Appuhami and Bhuyan 2015).
There are two types of incentive plans designed under this system that comprise of short term incentives plan (STI) and long term incentives (LTI) plan. STI are the scheme of incentives where the measurement period is usually one year and the payment is done in cash such as profit share, gain share, commission and bonus scheme. Organization makes use of short term incentives are gain sharing scheme, bonus scheme and profit sharing scheme. Such criteria of performance can be qualitative, non qualitative and non financial measures. Using the methods of profit sharing helps employees to give priority to the bottom line and become well aware of the profit margin (Chen and Jermias 2014). If the organization generates higher level of profits, then a larger share of percentage of profits are received by employees.
Organization generally make use of long term incentive plans for focusing on long term goals and creating linkage between bonus scheme and the overall long term performance. Such plans are based on stocks and options. In such schemes, the performance measurements are associated with the executive rights to receive or exercise options and obtaining stocks. Executives under this plan are granted with stock or options when they are able to achieve the target value for the specified performance measures. Such schemes have the operations that are intended to improve the employee’s incentive. In addition to this, this particular incentive approach also intends to lower the total amount of fixed cost attributable to this. The incentive of long term plan also incorporates plans of share options for promoting the stakeholder and executives interest. The main purpose of offering LTI to employees is to align the interest of executives and shareholder of companies and achieving long term objective of organization (Klettner et al. 2014). However, there are some challenges that are associated with the schemes of long term incentives plan because it is perceived by employees that the level of reward is associated with their performance. Compared to other form of compensation, the link between individual performance and the schemes of LTI is considered potentially weaker. The reason is attributable to the fact that such incentive plans are restricted towards higher level of employees who arguably directly impacts the overall performance of company (Australianshareholders.com.au 2018). Since the plan of LTI comes with restriction on cash and thereby on liquidity, employees who are provided with such benefits are not able to derive immediate benefits and value.
The Australian shareholder association is of the view that the incentive payment are too often made for less than the performance of superior and it is not well aligned with the returns that is generated for shareholders. It is provided by ASA that the bas salaries of executive remuneration should be sufficient for providing appropriate and adequate compensation when the performance of organization is adequate. The incentives to senior executive and chief executive officer should be provided through long term incentives. STI should be used when it is completely consistent with long term goals of organization and are questionable only to chief executive officer.
For the LTI plans, the guidelines of ASA advocate the following:
For the STI plans, the guidelines of ASA advocate the following:
Preparation of remuneration report of Qantas is the responsibility of board along with expressing opinion on the same based on audit that is conducted according to the Australian auditing standards. The disclosure of remuneration information is done by Qantas airlines in accordance with the section 300 A of the corporations Act, 2001 along with disclosure of remuneration information on KMP with the KMP that is define din the Australia accounting standard AASB 124 Related party disclosures. The detailed disclosure of statutory remuneration is disclosed in the tables. Objective of executive remuneration framework is to retain, motivate, attract and reward the capable team of executives. Such objectives are achieved by setting pay opportunity at a level that is appropriate and the performance of Qantas is linked to the outcome of remuneration (Riaz et al. 2015).
The board of Qantas airline is structured in a way that it helps in adding value and remuneration committee is one of the committees that form the part of board. Information about remuneration for the executive management, chief executive officer and non executive directors are set out in remuneration report. The remuneration report incorporate the summary of remuneration outcome of CEO, framework of remuneration that is applied for year 2016-2017 and changes that is made in remuneration framework. The cyclicality of aviation industry is reflected in the framework of executive remuneration and in the challenging environment, such framework has performed the good job of managing the outcomes of remuneration. Remuneration strategy of organization has helped in creating significant value for the shareholders and the same is reflected in price of shares. The non executive directors of Qantas are entitled to certain travel entitlements and statutory superannuation and it is considered as standard and reasonable practice in the aviation industry (Qantas.com.au 2018).
Executive remuneration framework of Qantas is applicable to executive management and CEO and is comprised of three elements that incorporate base pay, short term incentives plan and long term incentive plans. Base pay is the salary level that is guaranteed and is inclusive of superannuation. Bas pay for executive management and CEO is reviewed every year by the remuneration committee and it is guaranteed at salary level and is irrespective of performance of company. The board is required to make reference to external market data when performing a base pay review and primary benchmark that is used by the company is revenue based peer group of listed Australian companies. It is believed by the board that the benchmark used is appropriate as the role of comparator group best mirror the complexity, size and challenges in managing the business of Qantas (Qantas.com.au 2018).
STI on other hand is the plan of annual incentive for members of executive management of Qantas. The plan involves rewarding executives every year with a combination of restricted shares and cash to the extent to which the performance conditions of plans are met. Any description over the award that is made under STIP is retained by the board such as the outcome of the STIP scorecard can be adjusted by the board. It is also determined by the board that there will be either partial or no reward to the executive management and any award will be entirely deferred to the shares of Qantas (Qantas.com.au 2018).
Long term incentive plan of Qantas involves granting of rights over the shares. The rights are vested and converted to the shares of Qantas on a one for one basis if the service conditions and three years performance are satisfied. The rights become lapse if the performance conditions of three years are met. For each of the 2015-2017 LTIP, the measure of performance involves the relative total shareholder return of Qantas that is compared to companies with the ordinary shares and the relative total shareholder return of company compared to Global listed airlines (Qantas.com.au 2018).
For year 2017-2018, there are some changes that are approved by remuneration committee of Qantas by reviewing framework of executive remuneration. Remuneration framework is informed by the practice of market and it should take into account preferences and feedback of shareholders. In addition to this, the framework should also ensure continuous pay alignment with the performance, objectives of business and experience of shareholders (Psaros and Seamer 2015).
While determining the remuneration of executives, the main aim of the board is to motivate the executive team to meet the unique challenges faced by company being a major international airline of Australia. Moreover, it also intends to link the outcome of remuneration to the performance of business and overall performance of company. The approach used for remunerating executives of Qantas is ensured by the board that such approach will be demonstrating clear relationship between performance and pay. It also seeks to ensure that an appropriate balance is created between variable and fixed remuneration that would be reflecting both short term and long term performance objectives. It also involves the use of performance management framework for differentiating between higher and lower performers (Kent and Zunker 2017).
The above sections depict the analysis of literature review on the remuneration framework and importance of disclosure in the financial reporting of company along with detailed discussion on the remuneration framework of Qantas airline. As per literature review, there are various methods that can be used by organization in computing the incentives and determining the performance measures. However, the methods detailed in the literature are sometimes considerably different from the methods that are used practically. The reason is attributable to the fact that for practical representation of financial report and computing the incentives takes into account the relevant market factors and various other factors affecting the remuneration structure. Furthermore, reviewing of literature concerning the executive pay depicts that such factor should be associated with the organisational performance. It is indicated that strategy of remuneration should be well aligned with the performance of overall organization. From the analysis of remuneration report of Qantas airline, it can be inferred that remuneration strategy is designed by making appropriate alignment with the objectives of organization and meeting the commitments of shareholders (Sullivan and Mackenzie 2017). Furthermore, Qantas prepares its remuneration structure and make disclosure of remuneration information according to the remuneration regulations that is applicable to organizations operating in Australia and is in accordance with Australian standard.
The role of remuneration committee is to review and make recommendations to the board of directors on matters that are specific to executive remuneration at Qantas. Such role involves ensuring that the decisions of remuneration are appropriate from the perspective of performance of business of company. In addition to this, they are also required to ensure governance, performance of executives, market conditions and level of rewards. Remuneration committee during 2016-2017 has re appointed Ernst and Young as their remuneration consultant. In relation to use and appointment of remuneration consultant, protocols have been established by remuneration committee that intend to create support for compliance with corporation Act, 2001. During 2016-2017, remuneration committee did not seek recommendation on remuneration. The members of remuneration committee involve chief executive officer, chairman and independent non executive director and seven independent non executive directors (Kanapathippillai et al. 2016).
Under LTIP, a fair value methodology is used by Qantas during year 2016-2017 for determining the number of rights that is awarded to executive management and chief executive officer. The approach was used by remuneration committee for determination of number of rights granted and approach would change from fair to face value methodology of allocation during the year 2017-2018 (Shields et al. 2016).
Every year, approval of shareholders is sought by the Qantas for any award of rights made to chief executive officer at the annual general meeting. Under the LTIP for year 2017-2019, an award of 1172000 rights was approved by shareholders to CEO.
The above table depicts the calculation of equivalent face value and the value is disclosed in the annual report of company. A preference for the computation of LTIP awards using the face value of the underlying share instead of using fair value for right have been expressed by some shareholders and proxy advisors. This movement to face value approach is consistent with market practice and has commenced from 2017-2018. Such movement would require a one off conversion of the stated opportunity of target LTIP. An average of fair value discount is applied for this conversion that will have the consequence of executives being awarded for similar number of rights (Christensen et al. 2014).
The performance measure that is involved in the scorecard of STIP is the profit before taxation that is the key financial and budgetary performance measures. It is regarded a key performance measure that has 50% of the outcome of the STIP scorecard based on this. Performance measures for LTIP on other hand are relative total shareholder return that is compared with ordinary shares of company. It also involves relatives total shareholder return of Qantas compared to Global listed airlines. Determinations of performance measures are done against the performance of total shareholder return global airline peers and ASX100 companies (Shamsabadi et al. 2016). A number of other LTIP performance measures are also determined by remuneration committee that include return on invested capital. Under STIP, another performance measure that has been selected is the Qantas transformation program that is regarded as initiative of transformation for driving sustainable change within the organization (Fitzroy et al. 2016).
The financial and budgetary measures used by Qantas group in the STIP scorecard and the remainder of scorecard comprised of non financial measure as well. Such measure involves punctuality, net promoter score and advantage of domestic network. It is recognized by the management that there has been improvement in net promoter score resulting from continuous investment in customers. Measures of people safety and assessment of board on operational safety are the non financial measures used for determining STIP scorecard. There was full contribution under the measure of safety performance because of good performance of operational safety.
The board has made a number of changes as part of review of the framework of executive remuneration that was applicable from financial year 2017 as depicted in the annual report of Qantas. Relative weighting of the incentive plan opportunities for the CEO has changed from 2017-2018. This will consequently increase the weighting towards long term incentives and a decrease in weighting towards annual incentives. This particular change has been introduced by aligning the long term objectives of Qantas to CEO (O’Neill et al. 2016). Such changes have resulted in increasing the total pay opportunity to CEO.
Changes have also been introduced in the methodology used for allocating the award of rights from a fair value to face value. The disclosure of target LTIP opportunities for executives has been chosen by Qantas to be made on basis of fair value. Rather than using the fair value of the right, it has been preferred by some shareholders that for LTIP awards, face value of underlying shares should be used. Such shift in the approach was determined after it was viewed by remuneration committee (Bamber 2015). There has also been change in the pay mix for management.
The operational and financial performance measures are regarded as critical performance indicator and shareholder value driver. Outcome of performance measures of company is reflected in the remuneration outcome of executive management and CEO.
The share price of Qantas over the past three years has increased to $ 5.72 on 30th June as against $ 1.26 on 30th June, 2014. In year 2014, the LTI award that was made to executives were at higher level than normal year resulting from one off pay remix for executives. Such change was aligned with the management team and increased the weighting towards long term incentives. Growth in price of shares of Qantas in the last three years has resulted in increasing the remuneration outcome of CEO at $ 10.1 million. Moreover, via the LTIP, the additional amount of $ 14.5 million was released to CEO. Value of shares under the plan of incentive attributable to CEO and team of executive management has also increased (Habib et al. 2016). However, the impact of growth of share price on the valuation of equity awards is not reflected in the remuneration of statutory remuneration.
The outcome of remuneration for the executive management and CEO reflects the performance of share price. Share price of Qantas has more than doubled in the last few years and year 2016-2017 is regarded as an excellent year for performance of company. Incentives were paid under both the plan that is LTIP and STIP for the year 2015-2017. Furthermore, the outcome of scorecard of STIP is well aligned to the strong performance of business. Due to superior performance of total shareholder return, 100% of rights were vested under LTIP and over the past three years, 372% of the rights were vested. Value of LTIP was driven by $ 4.46 due to growth in share price and the total number of rights that were vested in year 2015-2017 is higher than the standard (Ward 2016).
In nutshell, the review of annual report of company relating to the remuneration framework can be summarized in the flowing points:
It can be seen that the Qantas make use of shareholder proxy advisers for seeking approval on the remuneration strategy. However, the concerns are expressed that the votes of clients are controlled by such advisers. Such advisory services do have wield influence and organization should not underestimate such influence. In this regard, it is recommended that such advisory services should provide issuers with elaboration of any negative recommendations and they should be capable of entering into dialogues with issuers that should be independent of corporate subscription. In addition to this, when considering the engagement of shareholders for deciding on the remuneration of executives, it is essential to look at overall interaction. Nevertheless, engagement with shareholders is considered central to the practices of good corporate governance; one of the key tools that should be taken into consideration by organization is the non binding vote on remuneration report. Involvement of shareholders in decision making should be constrained to key rights that can only be exercised in the annual general meeting of company. Furthermore, the incentive plans of company should be well aligned with the objectives and overall performance of company. There should be creation of greater link between the compensation plan and rewards and performance of employees (Li et al. 2015).
Conclusion:
The above discussion incorporates the analysis and comparison of methods used for performance pay by reviewing the literature and annual report of Qantas airlines. Reviewing of literature illustrates that organization make use of several methods for computing the performance pay and link the incentives plan with the performance of organization. It can be inferred from the analysis of annual report of Qantas airlines that the disclosure requirement of remuneration of executives is done in accordance with the appropriate legislations and regulations. Moreover, both the incentive plans that is short term and long term incentive plans and the associated performance measures are aligned with the overall performance of company. This leads to the strategic formation of remuneration framework and the remuneration committee has all the parameters determined in its place for determination of remuneration of executives. Qantas airline has made adequate disclosure on the remuneration report by making detailed explanations various aspects. It can also be concluded from the analysis that the method employed by organization for calculating the pay performance and remuneration of team of executive management is considerably different from the method that has been discussed in the literature review part. Therefore, the practical implication of the methods of remuneration is different as it involves factual market data and other relevant factors.
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