Discuss About The EVA Determinants Of Executive Compensation.
With the increasing complexity of the business, each and every key managerial person needs to make the effective strategic decisions to beat the competition in market. In this report, Woolworth Australian listed company has been selected to complete this report with the different assessment questions. In the starting managerial pay of the mangers and after that bonus plans and factors related to lending capital will be discussed.
The latest trends in economic environment have influenced business to make managerial pay dependent directly on the level of either the manager’s performance in achieving the organisational goals or on the firm’s overall result. This acts as a useful step in motivating the managers to work harder in achievement of business goals because they are somehow personally interested in the growth achieved. This enables them to push their limits to the level they would have never done themselves, if the pay they would receive would be fixed irrespective of their performance or firm results. However, this practice sometimes creates an environment of stress and disturbance for the managers and they have to deal with situations they might not like to face. This adversely affects their ultimate performance as they are just burdened for achieving results and due to this they hardly care on following even crook practices to achieve results. Some past evidences have shown practices of earning management being followed by the managers to reinstate the earnings to increase their own pay (Brown-Liburd, and Zamora, 2014).
Organisations need to balance these adversities. Instead of allowing remuneration entirely on the basis of financial statement’s earnings, some portion of pay scale must be based on real rise in share price, because it’s the real parameter to measure firm’s growth. A system must be set for pay-out that is based on real hard work and efforts done by the managers and not on the practice of earning management they may use to misstate earnings to increase their remuneration figure. Different pay scales should be made for achieving short and long-term goals. A balance must be achieved that promote achievement of financial and non-financial objectives, retention of skilled managers, increase in shareholder’s wealth etc.
The public listed company chosen is Woolworths limited and the compensation policies for the group CEO, Brad Banducci have been analysed to gather the following conclusions (Woolworths, 2017).
As per the remuneration report of Woolworths limited, the salary of the group CEO amounts to an annual fixed remuneration of AUD 2,500,000. It is inclusive of salary, superannuation and car allowance. This figure is fixed in nature and is based after taking into account the experience and skills, size and complexity of roles and the responsibilities burdened on him in his individual role (Woolworths, 2017).
The amount which is based on the long-term performance is termed as long-term incentive and is delivered in form of PERFORMANCE RIGHTS to the CEO, which will vest after three years subject to the performance. It is undertaken to ensure the CEO’s performance in line with company’s overall performance that goes in line with the overall shareholder return and business strategies.
The present CEO of Woolworth is Bradford Banducci who takes all the key managerial decisions. It is evaluated that 75% of CEO’s remuneration is performance based which is further bifurcated into target STI (short-term incentive) and Maximum LTI (long-term incentive). Short term incentive holds 25% portion and is payable as 12.5% cash and 12.5% deferred. While the long-term incentive amounts to 75% (Woolworths, 2017).
There is nothing stated such as bonus in the remuneration policy explicitly. However, as the 75% of the CEO’S pay is variable, he has certain targets to accomplish. If the performance achieved is beyond targets, then there is a possibility of stretch being created. The CEO is entitled to receiving cash short term incentive which is based on performance and could be higher than the target cash short term incentive. E.g. in financial year the actual cash short term incentive was AUD 1,510,000 as compared to AUD 1,250,000 of target cash short term incentive (Woolworths, 2017).
The measure of accounting performance used for determining the short-term incentive include, sales, EBIT, working capital, customer satisfactions and safety with all given a weightage of 20% each. The long-term incentive measures are based on relative total shareholder’s return with a share price gateway, sales per trading square meter and return on funds employed, with all given a weightage of 33.33% each (Brown-Liburd, and Zamora, 2014).
In order to maximise his bonus, the CEO must make policies that targets on boosting company’s sales. This will have a favourable impact on the earning before interest and tax. At the same time policy regarding suppliers should be analysed to bring cost effectiveness. The working capital should be managed by analysing the debt taking and extending patterns and investment of idle cash. Feedbacks must be a must to take from the customers and the employees as well regarding the value they received and working conditions respectively. This would ensure the customer satisfaction and worker’s safety (Olafsen, et al., 2015).
For the long-term incentive maximisation, the overall effort should be placed on betterment of quality and increasing the sales affected at every geographical location. When the shareholder’s wealth and sales shall increase, it will ultimately bring an overall rise in the return on funds employed. The performance of company is very effective and shown that company has grown by 19% since last three years (Shin, 2016).
Agency theory works as a principal agent model wherein the owners stand as the principal and the managers are their agents. The role of agents is to serve the principal’s motives i.e. increase in their wealth. Owners are the real shareholders. When the agents do not perform at the level required from them, there stands agency loss. Agents need to work hard and efficiently to reduce and remove the agency loss (Anderson, et al.., 2018).
The various components of remuneration discussed above include fixed pay and the pay dependent on performance. Performance linked pay can be justified in the agency theory. If the performance is efficient and generating results, the managers are bound to receive returns beyond minimum and targeted. It’s the same way as reducing of agency losses and performing with full vigour and with an aim to improve. The EBIT, sales, consumer satisfaction, employee safety, working capital, shareholder’s return etc all could certainly improve if the managers work in line with the business strategies with a goal to achieve business targets and improve performance (Jaskiewicz, et al. 2017).
The bonus plan is used to established nexus between the organization development and economic growth of the shareholders. Agency problem exist because of a conflict of interest between the managers and shareholders. The agents (managers) are required to perform tasks with a view to increase the return accrued to the shareholders in form of increased share price. This is obvious because they are recruited by the owners to perform for them because of their potential, qualifications and requisite skills. But when they are required to perform as per the requirements of the owners, they may not perform well if not paid accordingly.
Another issue arises when the managers while working invents areas where they can earn more even without working as per the discretion of the owners, e.g. by leaking company secrets to competitors for money, insider trading etc.
Both the above problems can be dealt with formulation of a performance-based bonus plan. I.e. the managers shall be paid more if they achieve the company targets and perform better than required. This way both the issues shall be dealt. The managers shall be working in the best interest of owners as they are personally benefitted with that too and at the same time they will be focused on company’s success and will not engage themselves in malpractices. The specific components shall include the target performance, level of increase in pay as performance get better, short and long-term benefits (Brown-Liburd, and Zamora, 2014).
Certain covenants in debt agreement that can reduce risk include appointment of bank’s nominees in company’s board, prior approval of bank before any acquisition or merger, non-dealing in the assets kept as security with bank ( Barkema, and Gomez-Mejia, 2018).
As discussed above due to agency relationships, the mangers sometimes might involve themselves in malpractices like earning management (reinstating financial figures), insider trading, cash absconding, sharing secret information (Lougee, and Wallace2008).
The bank should be concerned with this as this would bring the repayment of bank loan at risk. It is so because some of these practices could get severe to a level of bringing the company into the clutches of liquidation, and as a result bank’s money would be in risk (Liang, Renneboog,, and Sun, 2015).
Before lending loan, the bank should ask for company’s financial report for at least five previous financial years along with current financial year. The information must consist of the key ratios based on the company’s result. Through the analysis of company’s cash position, repayment of debt history, solvency, liquidity, creditworthiness, asset statement and financial backing, the bank would be able to understand the risk that lies in extending loan to a particular company in situation of economic downturn (Papenfuß, and Schmidt, 2015).
Conclusion
After analysing all the details, and facts on the managerial pay of the mangers, bonus plans and factors related to lending capital, it is inferred that each and every company needs to follow the proper work structure and strategic financial program to run the business effectively. If company wants to win over the market then it needs to analysis all the positive and negative factors before implementing the proper financial plans. The assessments of all the financial activities are utmost required for the balanced and transparent busienss functioning.
References
Anderson, R.W., Bustamante, M.C., Guibaud, S. and Zervos, M., 2018. Agency, firm growth, and managerial turnover. The Journal of Finance, 73(1), pp.419-464.
Barkema, H.G. and Gomez-Mejia, L.R., 2018. Managerial gompensation and firm performance: a general research framework. Academy of Management journal, 41(2), pp.135-145.
Brown-Liburd, H. and Zamora, V.L., 2014. The role of corporate social responsibility (CSR) assurance in investors’ judgments when managerial pay is explicitly tied to CSR performance. Auditing: A Journal of Practice & Theory, 34(1), pp.75-96.
Brown-Liburd, H. and Zamora, V.L., 2014. The role of corporate social responsibility (CSR) assurance in investors’ judgments when managerial pay is explicitly tied to CSR performance. Auditing: A Journal of Practice & Theory, 34(1), pp.75-96.
Fatemi, A., Desai, A.S. and Katz, J.P., 2003. Wealth creation and managerial pay: MVA and EVA as determinants of executive compensation. Global Finance Journal, 14(2), pp.159-179. Liang, H., Renneboog, L. and Sun, S.L., 2015
Jaskiewicz, P., Block, J.H., Miller, D. and Combs, J.G., 2017. Founder versus family owners’ impact on pay dispersion among non-CEO top managers: Implications for firm performance. Journal of Management, 43(5), pp.1524-1552.
Lougee, B. and Wallace, J., 2008. The corporate social responsibility (CSR) trend. Journal of Applied Corporate Finance, 20(1), pp.96-108.
Olafsen, A.H., Halvari, H., Forest, J. and Deci, E.L., 2015. Show them the money? The role of pay, managerial need support, and justice in a self?determination theory model of intrinsic work motivation. Scandinavian journal of psychology, 56(4), pp.447-457.
Papenfuß, U. and Schmidt, C., 2015. Determinants of manager pay in German state-owned enterprises and international public policy implications: 3-year study for sectors, performance and gender (No. 137). Working Paper, Universität Leipzig, Wirtschaftswissenschaftliche Fakultät.
Shin, T., 2016. Fair pay or power play? Pay equity, managerial power, and compensation adjustments for CEOs. Journal of Management, 42(2), pp.419-448.
Woolworths, 2017., Annual report., [Online]., Available at https://www.woolworthsgroup.com.au/icms_docs/188795_annual-report-2017.pdf., [Accessed 14th May, 2018].
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