Tomato bank

2 (a) Criticisms of remuneration committee The remuneration committee has demonstrated failures of duty in several areas. There is evidence of a lack of independence in the roles of the non-executive directors (NEDs) who comprise the committee. One of the main purposes of NEDs is to bring independent perspectives within the committee structure and shareholders have the right to expect NEDs to not be infl uenced by executive pressure in decision-making (such as from the fi nance directors). Two of the NEDs on the remuneration committee were former colleagues of Mr Woof, creating a further confl ict. The effect of this lack of independence was a factor in the creation of Mr Woof’s unbalanced package. That, in turn, increased agency costs and made the agency problem worse. There was a clear breach of good practice with the remuneration committee receiving and acting on the letter from Mr Woof and agreeing to the design of the remuneration package in such a hasty manner. Remuneration committees should not receive input from the executive structure and certainly not from directors or prospective directors lobbying for their own rewards. Mr Woof was presumptuous and arrogant in sending the letter but the committee was naive and irresponsible in receiving and acting upon it. There is evidence that the remuneration was influenced by the hype surrounding the supposed favorable appointment in gaining the services of Mr Woof. In this regard it lacked objectivity. Whilst it was the remuneration committee’s role to agree an attractive package that reflected Mr Woof’s market value, the committee was seemingly coerced by the finance director and others and this is an abdication of their non-executive responsibility. The committee failed to build in adequate performance related components into Mr Woof’s package. Such was the euphoria in appointing Mr Woof that they were influenced by a clearly excitable finance director who was so keen to get Mr Woof’s signature that he counselled against exercising proper judgement in this balance of benefits. Not only should the remuneration committee have not allowed representations from the FD, it should also have given a great deal more thought to the balance of benefits so that bonuses were better aligned to shareholder interests. The committee failed to make adequate pension and resignation arrangements that represented value for the shareholders of Tomato Bank as well as for Mr Woof. Whilst pension arrangements are within the remit of the remuneration committee and a matter for consideration upon the appointment of a new chief executive, shareholder value would be better served if it was linked to the time served in the company and also if the overall contribution could be reconsidered were the CEO to be removed by shareholders for failure such as was the case at Tomato Bank.

(b) Components of a rewards package The components of a typical executive reward package include basic salary, which is paid regardless of performance; short and long-term bonuses and incentive plans which are payable based on pre-agreed performance targets being met; share schemes, which may be linked to other bonus schemes and provide options to the executive to purchase predetermined numbers of shares at a given favourable price; pension and termination benefi ts including a pre-agreed pension value after an agreed number of years’ service and any ‘golden parachute’ benefits when leaving; plus any number of other benefits in kind such as cars, health insurance, use of company property, etc. Balanced package is needed for the following reasons

The main way of doing this is to ensure that executive reward packages are aligned with the interests of principals (shareholders) so that directors are rewarded for meeting targets that further the interests of shareholders. The debate is partly about legal entitlement and ethical responsibility. Mr Woof’s reward package should have been subject to the same detailed design as with any other executive package. In hindsight. (c) Ethical case for repaying part of pension Mr Woof was the beneficiary of a poor appointments process and his benefits package was designed in haste and with some incompetence. He then clearly failed in his role as a responsible steward of shareholders’ investments and in his fiduciary duty to investors. the internal audit function were to signal a high level of exposure to an unreliable source of funding. Accordingly. As it stands. during which time he need not worry about the effects of excessive risk on the future of the company. He traded freely on his reputation as a good banker and probably inflated his market value as a result. such a ‘self-policing’ agency mechanism is clearly of benefi t.The overall purpose of a well-designed rewards package is to achieve a reduction (minimisation) of agency costs. it was his strategies that were to blame for the crisis created. more akin to behaviour at Kohlberg’s level 3 . Although Mr Woof came to Tomato Bank with a very good track record. as he has a generous pension to receive thereafter. such reward packages involve a bonus element based on specific financial targets in line with enhanced company (and hence shareholder) value. a pension value linked to performance and sensitive to the manner of leaving would have been a worthwhile matter for discussion and also the split between basic and incentive components. Although he is legally entitled to the full value of the pension. These are the costs the principals incur in monitoring the actions of agents acting on their behalf. Typically. the worst that can happen to him is that he survives just two years in office. Although ambitious to design. past performance is no guarantee of future success. A reward package that only rewards accomplishments in line with shareholder value substantially decreases agency costs and when a shareholder might own shares in many companies. for example. It is evident that Mr Woof is being self -serving in his dealings and in this regard is operating at a low level of Kohlberg’s moral development (probably level 1 in seeking maximum rewards and in considering only the statutory entitlement to these in his deliberations). In 15 exposing the bank to financing risks that ultimately created issues with the bank’s economic stability. The fact that he is receiving such a generous pension is because of his own lobbying and his own assurance of good performance places an obligation on him to accept responsibility for the approach he made to the remuneration committee five years earlier. it would have been helpful if the reward package could have been made reviewable by the remuneration committee so that a discount for risk could be introduced if. A more developed sense of moral reasoning would enable him to see the wider range of issues and to act in conformity with a higher sense of fairness and justice. it is the perception of what is fair and reasonable that is at stake.

etc. the two types of organisation are different in terms of regulation. This means that unless there is an overwhelming reason not to disclose information of any kind (perhaps for reasons of commercial sensitivity) then information should be disclosed or made available upon request to any interested . The second difference is in the strategic purpose of the organisation. wealth and value for shareholders. i. Thirdly. the two are different in terms of stakeholders and societal expectations. This often involves favourable tax treatment and different reporting requirements. impose a number of obligations upon listed companies such as non-executive directors. (b) Transparency Define transparency Transparency is usually defined in terms of openness and adopting a default position of information provision rather than concealment. including salaries and benefits. the operating board is usually accountable to a board of trustees. It is likely to be a social or benevolent cause and funds are donated specifically to support that cause and this expectation places a different emphasis on the purpose of governance. must receive recognition by a country’s charity authority to operate and they then 12receive the concessions that charitable status confers. Charities. depending upon the country’s rules. to maximise long-term cash flows. share price movements and price/earnings. It is the trustees who act as the interpreters and guarantors of the fiduciary duty of the charity (because the beneficiaries of the charity may be unable to speak for themselves). For a charity. they may be subject to audit and have some reporting requirements. This means that they employ and incentivise people.lalland 3 (a) Charities and public listed companies Differences Firstly.e. are consistent with those purposes. it can create jobs. by supplying its inputs (including working for it) or buying its products. Governance arrangements There can be a number of substantive differences between the governance structures of public companies and charities. cash flows. Value is added by the creation of shareholder wealth and this is measured in terms of profits. Stakeholders in a business often have an economic incentive to engage with the organisation whereas most stakeholders in a charity have claims more concerned with its benevolent aims. In a charity. including directors. The trustees ensure that the board is acting according to the charity’s stated purposes and that all management policy. A charity’s social legitimacy is tied up with the charity’s achievement of benevolent aims. committee structures. The principals are able to hold the board accountable through AGMs (annual general meetings) and EGMs (extraordinary general meetings) at which they can vote on resolutions and other issues to convey their collective will to the board. In a public company. Listed companies exist primarily to make a financial return for their investors (shareholders). Listed companies are subject to all the provisions of company law plus any listing rules that apply. Listing rules. a board consisting of executive and non-executive directors is accountable to the shareholders of the company. such as the need to adopt the Combined Code in the UK. the strategic purpose is to support the charitable cause for which the organisation was set up. in turn. Society expresses its support for a business by participating in its resource or product markets. Because charities are not public companies they are not subject to listing rules although. a range of reporting requirements. Society typically expects a business to be efficient in order to be profitable so that. in contrast.

Public commentators like journalists are capable of causing damage to HHO’s reputation and this in turn can affect donations and support for the organisation. To check for compliance with relevant regulation and codes refers to HHO’s compliance with its legal and other regulatory constraints. The case for greater transparency at HHO Transparency is an important principle in corporate governance. It does not give any absolute financial figures. There are a number of potentially damaging allegations made against Mr Hoi including the likelihood of large payments to himself and some profligacy in the purchase of the private jet. For a charity receiving money from ‘well -meaning individuals that care greatly about animal suffering’. checks for compliance with relevant regulation and codes. including at HHO. although the case does not permit definite and specific allegations of IC deficiencies to be made or to conclude that a complete lack of governance structure exists at HHO. would be information of considerable interest. at first glance. the most important areas for audit committee attention are monitoring the adequacy of internal controls. there are internal risks that the controls need to be capable of controlling. donors give money to support the charity’s stated aims and purposes. such as salaries. There are grounds for believing that inadequate remuneration policies exist at HHO and grounds for suspecting some financial dishonesty. of an attempt at concealment and this provides a strong reason to provide a full financial statement. for a number of reasons. Transparency would inform and placate HHO’s critics. It may also have voluntary codes it seeks to abide by. It is likely that HHO has a number of regulatory constraints as a result of its charitable status. the allegations have the potential to do much reputational damage to the charity. In the case of a charity. such as HHO. With regard to the situation at HHO. especially if the . In general. 13 Monitoring the adequacy of internal controls involves analysing the controls already in place to establish whether they are capable of mitigating risks. without shareholders in the conventional sense. be a priority at HHO. and the audit committee could also test for compliance with these. in terms of income and costs. the amount of money diverted for other purposes. for example. to any informed observer. any such organisation would benefit from having an audit committee with wide -ranging powers and responsibilities when reviewing internal controls. With the relief of suffering to animals being a prominent reason any donors give to HHO. The risk of fraud and the risk of compliance failure are relevant internal risks. However. including the journalists who are investigating it. In the case of HHO. Such a truncated summary actually gives the impression. perhaps made public through its marketing or reporting literature. Checking for fraud is also within the remit of an audit committee and this would. These allegations could be rebutted if the organisation were to make the accounts public and explain the case for the purchase of the jet. transparency has the effect of reassuring investors that their funds are being responsibly stewarded and used for worthwhile investments. This would not meet any stakeholder’s information needs and fails to address any of the concerns raised about HHO. checking for fraud and reviewing existing IC statements for accuracy.stakeholder. (c) Audit committee and internal controls There are a number of apparent internal control deficiencies. The publication of the financial data is an inadequate expression of transparency and appears to be a poor attempt to give the appearance of providing information whilst providing no useful detail at all. There also seems to be a lack of accountability for the behaviour and actions of Horace Hoi.

The misuse of donations for personal enrichment would be outside of what is allowed under his charitable status and this could be reviewed by the audit committee. for example reviewing major expenses and transactions for reasonableness. an audit committee could play a more supervisory role if necessary. This might include measuring transactions against its regulatory regime and the reasonable expectations of its trustees and donors . about his lavish lifestyle are accurate.

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