Corporate Governance & Executive Compensation
Managers are agents of Shareholders. Often there is a lack of congruence in the objective of the shareholders (principals) and managers (agents). This leads to agency costs which represents a loss in the value of the firm. The aim of this course is to reduce such agency costs.
Divergence of Interest
Institutional imperative: divergence between the goals of shareholders and managers. Decision Mgmt ShHolders Performance CF Sh ROR Sources of Fin RE Debt Debt RE Equity Equity
Worker>Low Level Mgr> Middle Level Mgr>Top Level Mgr>Board of Directors.
Internal monitoring: Performance monitoring and responsibility accounting. managerial compensation may be linked to shareholders returns. performance bonuses (sometimes) reduce agency costs. Stock Option. Incentive Compensation Contracts.Devices for Containing Agency Costs -Internal Devices. To make interests more congruent.
Also referred to as the takeover market.External Devices. Helps in rescuing hapless shareholders from the clutches of inept management. Proponents of takeover argue that an active market for control is a good external disciplining device.
Market for Corporate Control: when internal control do not work.is traded.
. the market for corporate control may act as a deterrent on managerial behavior that dissipates shareholder value. it is a market in which the right to control represented by a chunk of equity holding that is sufficient to wield control.
Market can make a manager pay a price for self-serving behavior.
Managerial Labour Market: Reputation and track record of a manager.
. However it is difficult to isolate the effect of managerial action from other influences which shape a firms performance.
– Professional Managers who have negligible stake.Typical executive considers himself John Wayne (Seathji). wielding complete control. – Myopic outlook of institutional investors builds pressure on management to report good earnings performance in the short run.Corporate Governance in Industrially Developed World
– Individual and Institutional Investors.
Active market for corporate control providing credible threat of take over. stiff penalties for price manipulation.
. insider trading laws.A small and growing number of investors are playing an active role in corporate governance. Tight disclosure norms.
Checks on insider trading is not too high.
– Banks and financial institutions have substantial stakes in the equity capital of the companies. – Disclosure norms are not too stringent. – They play an active role in the management of the firms.
. impairing on the efficiency of the capital markets.
Corporate Governance in India
Management by chromosomes. politicians. and mangers taking a myopic view of things. viz.
. Entrenched System In the public sector
– Transient system with key players. bureaucrats.
Reforming Corporate Governance
Strengthen the hands of Institutional Investors. Separate Management from Control
– Management Initiation Implementation under Chairman
Control Ratification Monitoring Under MD
Cumulative Voting system Improve Corporate Accounting and Reporting Practices. Link Managerial compensation to performance.
.Expand the Role of Non-executive Directors. Enhance Contestability. Ensure that the board is Informationally well equipped. Limit the Size of the Board.
Goldman Sachs Group. individual directors and management should perform their functions.
. its various committees. and to ensure a common set of expectations as to how the Board. to promote the interests of stockholders. Inc
Introduction:effective functioning of the Board and its committees.
Read the handout –pay special attention to VI. The Committees of the Board
invest b)declare dividends c) Appoint MD – Total remuneration of the directors is subject to a ceiling of 11% of net profits.
. – BOD punishable for breach of trust.Sitting fees subject to some limits.lend. BoD have power to a)borrow.Legal Provisions v/s CII code
Companies Act 1956
– – – – Limited co must have at least 3 directors Board must meet at lease once in a quarter No person can be a director of more than 20 cos. dishonesty and fraud. – BOD has a duty to present the Annual Report to the members.
In an attempt to improve the quality of corporate governance.
. CII has suggested a code for its members.
club membership. Benefits include furnished accommodation. benefits and incentive compensation. LTA and so on. Incentive compensation is typically in the form of an annual bonus which is linked to performance measured commonly in terms of certain accounting numbers. pension and gratuity benefits.
. chauffer driven car.Executive Compensation
Key elements of Executive compensation in India are salary. medical reimbursement. Occasionally it is In the form of stock options or reward of shares.
specific risks as they have greater concern about the security of their job and growth prospects with the firm. Varying time horizon s: Managers-short term results shareholders are interested in long term creation of value. on the other hand are not inclined to accept high firm.Conflict of Interest
Excess perquisites hurt the interests of the shareholders. Differential risk attitudes: Sh holders are willing to accept more firm specific risks as they can wash them away through diversification in the capital market.
Emphasis on short term performance. Linkage between size and pay.
.Failure of Executive Compensation Plans to Promote Value Creation. Reliance on accounting measures which are poor proxies for value creation.
– Reward relative measures. – Choose the Appropriate Level of Risk Posture and Time Focus.
. – Use Objective criteria – Select the right set of performance measures.
– Integrate the Incentive plan into the total compensation Architecture.Designing an Incentive Compensation Plan
A well conceived incentive compensation plan goes a long way in aligning the interests of managers and shareholders.
Ensure tax Efficiency. Lengthen the Decision making Horizon of the Executives. Employ Stock Options Judiciously.Discourage parochial behavior. Abandon attempts to measure what executives control.
– Not a promoter. – Compensation committee consisting of a majority of independent directors. for advice and supervision of the ESO scheme. – Pricing – Lock in period and rights of the option holder. – No ESOS unless shareholders pass a special resolution.
. not a director who holds more than 10% of the outstanding Equity Shares.