The Achilles' Heel of Executive Remuneration Policy
3分钟的家长会发言稿-学校对教师的评价
Corporate Personality: the Achilles’ Heel
of Executive Remuneration Policy
Chrispas
Nyombi*
Salomon and Co Ltd, the
grandfather of modern public companies, laid a
firm
platform for their emergence in 1897, at
a period when company law was sawed in the
soil of partnership law and equitable
principles.
1
The platform was based on
limited
liability which secured promoters of
companies from liabilities and corporate
personality which guaranteed that the company
was separate from the promoters.
2
This
platform still stands today having endured a
challenging 20
th
century where a
company’s ability to pass off its liabilities
to third parties was often challenged by
unsatisfied creditors seeking to make the
promoters accountable and liable. Today,
companies continue to flourish under Salomon
principles and have exploited the wide
range
of capital available to them by growing larger and
becoming more influential
around the world.
Their reach and wealth has kept the wheel of
capitalism spinning
and contributed to the
growth of economies around the world. Their
continued rise
and establishment has also
exacerbated market competition to the benefit of
society at
large.
The UK government
has sought to protect the interests of their
public companies and
monitor their impact
through company law statues
3
and corporate
governance
principles.
4
They are
guided by a belief that the maladministration of
these
corporations could have a far-reaching
impact on society and detrimental to the UK
economy. A foremost example of legal
interventions in corporate affairs is the newly
availed enlightened shareholder value under
the Companies Act 2006.
5
Enlightened
shareholder value calls for the consideration
of all company constituents such as
employees
and the community in the decision making process.
This is to prompt
companies to focus on long
term survival rather than short term gain
shareholders so
often seek.
*Chrispas Nyombi ( Lecturer in Corporate Law,
PhD Candidate)
1 Salomon v A Salomon & Co Ltd
[1897] AC 22- A landmark decision in British
Company Law
2 See Lee v Lee’s Air Farming Ltd
[1961] AC 12
3 Companies Act 2006 (CA 2006),
Insolvency Act 1986 & Enterprise Act 2003
4 UK
corporate Governance Code 2010 (formerly Combined
Code)
5 s172 CA 2006
Electronic copy
available at:
http:tract=2032584
1
Despite the
increased endorsement of enlightened shareholder
value, the UK
government has largely failed to
put a hold on excessive executive remuneration.
This
has been a much debated issue in UK and
across the Atlantic,
6
inflamed by
corporate
governance failures in the banking
sector during the 2007-2009 global financial
crisis.
7
In the aftermath, banks such
as Royal Bank Scotland (RBS) reportedly
continued to reward large bonuses to their
executives even when they were still being
financed by government bailout money.
8
This paper explores the role corporate
personality has played in the battle between
executive remuneration and fairness, which is
linked to rewarding performance. This
paper
also explores some of the policy measures taken by
the UK government to curb
excessive
remuneration especially in the banking sector.
Overall, the paper shows
how the ruling in
Salomon, over a century ago, that cemented
corporate personality
and limited liability in
UK, is hampering many of the measures aimed at
rewarding
performance and promoting fairness
in relation to executive remuneration.
The Companies Act 2006 was enacted on the
basis that the paradigm private company
is
family owned. This so called “think small first”
government agenda is an
endorsement of
entrepreneurial activity rather than the rules of
equity or notion of
fairness.
9
It is
evident that the rationale behind the 2006 Act was
to create a more
economically efficient regime
while preserving the established legal dictum.
Most
cases following Salomon reveal the most
remarkable yet remarkably unremarked
upon
facet of modern company law; it does not concern
itself with fairness.
10
For
example,
the corporate opportunity doctrine, a 20th century
legal development, holds
that a company
director cannot compete or take an opportunity
which the company
has an interest
in.
11
The basic principle was settled in
Aberdeen Railway Co v Blaikie
Bros per Lord
Cranworth LC ‘it is a rule of universal
application that no one having
(fiduciary)
duties to discharge shall be allowed to enter into
engagements in which he
6 Rampling, P (2011) CEO and Executive
Director Remuneration and Firm Performance
Southern Cross Business
School: Southern Cross
University: p.23-29
7 Hill J,(2011) Regulating
Executive Remuneration after the Global Financial
Crisis: Common Law Perspectives
Sydney Law
School Research Paper No. 1191
8 RBS Bonuses
amid failure-
http:ness2012feb23rbs-
commercial-status-2bn-loss
(Accessed 19032012)
9 Modernising Company Law Cm 5553-I and II
(London: TSO, 2002).
10 (Salomon v Salomon,
Percil v Wright, Guiness v Saunders, Regal v
Gulliver)
11 See Cook v Deeks [1916] 1 AC 554
Electronic copy available at:
http:tract=2032584
2
has…a personal
interest conflicting…with the interests of those
whom he is bound to
protect’.
12
To
illustrate the unfairness attached to the
doctrine, take Re Bhullar Bros
Ltd as an
example, a director took legal advice, got company
land and developed it
himself.
13
The
court held that he abused his position as under
the corporate
opportunity doctrine. Similarly,
in Industrial Development Consultants Ltd v
Cooley,
a company could not afford a contract
and a director resigned and took it
over.
14
The
court held that it was a
breach of his fiduciary duty under the corporate
opportunity
doctrine and any profits are held
on constructive trust to the company, even though
the company was in no position to take over
the contract.
15
Judging from the ruling in
Bhullar and Cooley, the 20
th
century
legal approach to corporate opportunities is
fettering economic development.
Modern companies depend on a highly
specialised and skilled workforce to steer their
businesses towards success for the ultimate
benefit of the investors.
16
It is thus
safe to
conclude that the value making of
these entities lies with the workforce, an
intermediary between profit and loss. The
directors invest their skills and expertise to
receive remuneration in return.
17
Corporate profits thus represent unremunerated
work
and to some managerial theorists with
background knowledge of economics, it is a
form of exploitation.
18
According to
Bebchuk et al,
19
in reality remuneration
is settled
through a rigged process where
powerful managers and their far-reaching influence
dominate committees and extract economic rents
to the shareholder’s detriment. A
director is
under no obligation to hold office and article 4
schedule 1 of Human Rights
Act 1998 does not
offer directors the right to remuneration on
grounds of
enslavement. Moreover, schedule 1
paragraph 19 of the Companies (Model Articles)
Regulations 2008 allows directors to be
remunerated.
20
12 (1854) 1 Macq 461 at at 471-472
13
[2003] EWCA Civ 424
14 [1972] 1 WLR 443
15
Chan v Zacharia (1984) 154 CLR 178
16 Agrawal,
A., and Walkling, R. (1994). Executive Careers and
Compensation Surrounding Takeover Bids,
Journal of Finance, 49 (3), 985-1014
17
Fee, C. E. and C. J. Hadlock, 2001, “Raids,
Rewards, and Reputations in the Market for CEO
Talent,” Working
Paper, Michigan State
University.
18 Baumol, William J.
19
Bebchuk, Lucian A. & Jesse Fried. Pay without
Performance: The Unfulfilled Promise of Executive
Compensation (Harvard University Press 2004).
20 The Companies (Model Articles) Regulations
2008 (SI 20083229)
3
The doctrine
of corporate personality plays a major role in
executive remuneration by
leaving directors in
charge and mainly subject to market discipline.
Companies Act
2006, section 40(1) reads that
“in favour of a person dealing with a company in
good
faith, the power of the directors to bind
the company, or authorise others to do so, is
deemed to be free of any limitation under the
company’s constitution.” This maintains
that
shareholders are allowed limited rights of
intrusion in the company’s affairs. As
stated
in Guinness plc v Saunders, having disparately
invested in companies, “the
shareholders…run
the risk that the board may be too generous to an
individual
director at the expense of the
shareholders but the shareholders have…..chosen to
run
this risk and can protect themselves by
the number, quality and impartiality of the
members of the board who will consider whether
an individual director deserves
special
reward”.
21
During the 80s and
90s, executive stock options became an
increasingly important
feature of remuneration
package, especially in the banking
sector.
22
Today, this is a
widely used
mechanism in many commercial banks and other
organisations.
Executive remuneration packages
are largely composed of a base salary, annual
bonus, stock options andor restricted shares,
and often other long-term incentives.
This is
deemed to be a reward for their skills and
experience which in most instances
might be
scarce. Thus to induce an executive to take and
retain a position, a firm must
offer a package
of benefits that meets or exceeds the executive’s
opportunity costs.
However, directors
are often being paid exorbitantly for mediocre and
at times subpar
performance. Remarking on the
situation, in 1998 Warren Buffett commented,
“there
is no question in my mind that mediocre
CEOs (Chief Executive Officers) are getting
incredibly overpaid. And the way it’s being
done is through stock options”.
23
This is
today being demonstrated by firms like RBS who
are still paying out astronomical
bonuses and
other market oriented rewards when a few months
back they were
tittering on the brink of
collapse. Shell’s remuneration committee was
recently able to
21 Guinness plc v Saunders [1990] 2 AC 663 at
686).
22 Murphy, K. (1995), Politics,
economics and executive compensation . University
of Cincinnati Law Review
63(2).
23 Shawn
Tully, Raising the Bar, Fortune 272 (June 8, 1998)
4
hand out gargantuan bonuses even
though set targets were missed.
24
The
problem is
exacerbated by excessive severance
packages for professional managers that incur
poor performance. For example, RBS former CEO
Fred Goodwin took out a £703,000
retirement
package, although it was reduced after being
succumb to media pressure, it
clearly
indicates the challenges facing investors
today.
25
For decades, financial
economists, both theorists and empiricists, have
sought to
explain the various features of
executive compensation arrangements.
26
Theoretically,
optimal compensation contracts
are a result of effective arm’s length bargaining
between the board of directors and the
executives. In this process, the optimal
contracting scholarship views remuneration
committees as serving shareholder
interests
exclusively and bargaining with management in an
arm’s length fashion.
27
However,
despite the supposed independence of most
compensation committees,
there are numerous
reasons to be sceptical on whether the process
amounts to the
arm’s length ideal. The major
problem is the insidious influence of management.
Main, O’Reilly, and Wade found that
independent directors are influenced by
reciprocity and authority when setting
executive pay.
28
However, Fama et al.
argue
that independent directors have an
incentive to develop reputations as experts in
decision control, which they can do by
safeguarding shareholders interests and thus
setting competitive remuneration
packages.
29
In addition, Wade,
Porac, and Pollack provide some evidence that
companies use pay
consultants in justifying
executive compensation to outsiders, mainly
shareholders.
30
Although consultants
play a useful role in designing pay packages and
gathering data,
they could also play a role in
camouflaging rent, having been hired from a
company’s
24 Shell’s high bonuses
http:ncebreakingviewscom5284495Shell-bonus-row-
misses-
(Accessed 18022012)
25 Fred
Goodwin’s pension http: (Accessed 18012012)
26
Bebchuk, Lucian, Jesse Fried, and David Walker
(2002), “Managerial Power and Rent Extraction in
the Design
of Executive Compensation,”
University of Chicago Law Review, 69, 751–846.
Bebchuk, Lucian and Oren Bar-Gill
(2002a),
“Executive Compensation with Short-term
Incentives,” Working Paper, Harvard Law School
27 (Brudney, V. 1982. The independent
director—Heavenly city or potemkin village?
Harvard Law Review, 95:
597-659.
28 Main,
Brian G.M., Charles A. O’Reilly and James B. Wade,
1995. The CEO, the board of directors and
executive compensation: Economic and
psychological perspectives. Industrial and
Corporate Change, 4: 293-332.
29 Fama, Eugene
F. and Michael C. Jensen. “Separation of Ownership
and Control.” Journal of Law and
Economics 26
(1983b) 301-25.
30 Wade, J.B., O'Reilly, C.A.
& Pollock, T.G. 2006. Overpaid CEOs and underpaid
managers: Fairness and
executive compensation.
Organization Science, 17(5): 527-544
5
human resources department. Indeed,
the threat of losing the consultancy is likely to
keep the consultant in line, and consequently
their data usually justifies objectively
the
rising remuneration levels. In a competitive
market, it is argued that inefficient
behaviour produces competitive disadvantage
and shrinking profits.
31
Although this
effect may discourage management from acting
in ways that decrease productivity,
the
redistribution of firm profits from shareholders
to executives has no significant
effect on the
company.
32
Since neither market
forces nor bargaining between the board and the
executives is
likely to ensure optimal
contracting, in theory, such contracting could
arise if
shareholders and courts had the power
to block the remuneration packages. Indeed
section 168 of Companies Act allows
shareholders to dismiss a director without
cause, but the compensation package for
contract termination could be astronomical.
Although rarely done, shareholders have the
power to reject director remuneration
reports.
33
However, corporate
personality prohibits courts from intervening in
company affairs. In Carlen v Drury per Lord
Eldon LC “this Court is not to be
required on
every occasion to take the management of every
Playhouse and
Brewhouse in the
Kingdom.”
34
The case of Guinness plc v
Saunders established that
courts are in no
position to determine equitable allowance or
remuneration.
Section 172 of the
Companies Act 2006 empowers directors to promote
the short term
and long term success of the
company. However, if directors pay themselves high
salaries, it is difficult to prove that it is
not in the short term or long term good of the
firm. The shareholders need to establish
dishonesty and the director needs to establish
reasonable degree of care. As long as an
independent remuneration committee
approves
the remuneration report and auditing is carried
out, then there is limited
room for
argument.
35
It is indeed difficult to
prove that remuneration levels are too
high
and if courts did, it would seem like they are
intervening in the management of
companies.
This position is consistent in Re
Keelefs,
36
Re Duke of Norfolk’s
37
and
31 Easterbrook, Frank H. “Two Agency-Cost
Explanations of Dividends.” American Economic
Review 74 (1984)
pp. 650-59.
32 Ibid
33 S420 requires directors to produce a
remuneration report. S 439 allows shareholders to
vote on it.
34 (1812) 35 ER 61, 62
35
See the more astringent business judgement rule in
US
36 Re Keelefs S. T. [1981] Ch. 156
6
number of other rulings.
38
However, if the board was not acting collectively,
the court
can strike down the remuneration pay
on constitutional grounds.
39
As
aforementioned, optimal contracting is rarely
reached since company owners
reside outside
the organisations and the power ultimately lies
with executives who set
pay levels that are
often not of arm’s length ideal. While the
separation of ownership
and control is an
inherent feature of the public company, the
subsequent reliance on
the market to induce
management to promote the success of the company
seems to be
failing to exert control over
managerial remuneration. The managerial power
approach follows on the limitations of optimal
contracting approach by
acknowledging that due
to the considerable influence of management over
the board,
bargaining over executive
remuneration does not usually approach the arm’s
length
ideal. Interestingly, Habib &
Ljungqvist’s study suggests that the design of
option
programs is consistent with the
presence of managerial power and rent
extraction.
40
Since rent extraction is
associated with managerial power, the managerial
power
approach suggests that there is a
correlation between managerial power and
rents.
41
However, an important
factor affecting executives’ ability to increase
their
remuneration is the outrage the
excessive pay package could cause. Indeed the need
to
get the board’s consent to executive
remuneration does not produce the same outcome
as arm’s length bargaining. If not of arms
length ideal, outsiders might become upset,
as
in the case of Fred Goodman at RBS. Outrage might
produce various social and
reputational costs
to executives. Even though excessive remuneration
is unlikely by
itself to trigger a challenge
to managerial control, outrageous increases in
remuneration could amplify the likelihood of
such an attempt, mainly from
institutional
shareholders.
42
It must be noted, however,
that outrage costs depend on
how easily and
distinctly they can be identified. Thus an
extraction of rents will cause
37 Duke of Norfolk's S.T. [1982] Ch. 156
38 Bristol and West Building Society v Mothew
[1996]; Ch. 1, O'Sullivan v. Management Agency
[1985] Q.B. 428
Bairstow v Queens Moat
Houses Plc [2001] EWCA Civ 712; Re Halt Garage
(1964) Ltd [1982] 3 All ER 1016; Re
Cumana
[1986] 2 BCC 99453; Craven-Ellis v. Canons Ltd
[1936] 2 KB 403 and Re Duomatic LW [1969] 2 Ch 365
39 The articles of association are the
constitution of the company. S33 CA
40 Habib,
Michel and Alexander P. Ljungqvist (2000), “Firm
Value and Managerial Incentives,”Working Paper,
London Business School.
41 Hirshleifer,
David, 1989.
Determinants of Hedging and Risk
Premia in Commodity Futures Markets,Journal of
Financial and Quantitative Analysis, Cambridge
University Press, vol. 24(03), pages 313-331,
September.
42 Ibid
7
no harm
if it can be camouflaged. However, shareholder
resolutions which disapprove
of executive
remuneration reports can lead to reductions in pay
even though these
resolutions are nonbinding.
Shareholders’ judgement is however subject to
question;
they approved Fred Goodman’s payout
and only after the media intervened, then they
voiced their concerns. Fred Goodman
voluntarily reduced the payment, but it does
cast doubt on shareholders ability to question
or pass resolutions on remuneration
reports.
Conventional options reward managers for
increases in the share price even when
those
increases are due solely to factors beyond
managerial control, such as interest
rates.
Even managers who perform well are impacted upon
by macro forces.
However, to reduce this
effect, some measures that can be taken include
indexing the
exercise price of options. Stock
options could be designed with an exercise price
that
rises or falls with either sector or
broader market movements. The vesting of options
could also be made dependent on the share
price exceeding a certain benchmark.
However, it is recognised by Bebchuk, Fried
&Walker that firms almost never employ
any
version of reduced-windfall options, even though
these options contain features
such as an
indexed exercise price capable of screening out
market effects.
43
The main
approach to
formulating reduced windfalls is that of indexing
the exercise price of the
option to the
performance of the sector or the market, thus
filtering out non company
related factors. For
example, an executive is offered 1500 options at
£100. If a market
rises by 30% from the period
options were granted, the exercise price would be
£130.
In this instance, a firm is able to give
more options to the managers, at the same cost
and reward value created by the managers. The
index can also be adjusted to measure
the
bottom quartile of the industry if the former
approach is deemed unfitting.
However,
Holmstrom argues that indexing the exercise price
of options could reduce
the executive’s
exposure to market risk.
44
He claims that
older, wealthier executives
can always offset
the market risk generated by non-indexed options
through the
reduction of their equity
portfolios.
43 Supra 26 p.5
44Bengt Holmström, 2001.
LAPM: A Liquidity-Based Asset Pricing
Model,Journal of Finance, American Finance
Association, vol. 56(5), pages 1837-1867,
October
8
Another approach is
performance-conditioned vesting of options. Under
this
approach, those managers who do not meet
certain performance targets forfeit their
options. The exercise price is usually set to
the market price on the date of grant.
Thus,
if the executive is permitted to exercise the
options, heshe can profit to the full
extent
of the stock price appreciation. The options do
not become exercisable (vest)
unless certain
performance targets are met. Thus the manager
receives no payout
unless the share price
exceeds a certain benchmark.
45
A
final mechanism is to make vesting conditional on
the firm’s earnings per share, net
asset
value, return on capital, and or cash generation.
Such measures might not screen
out sector-wide
effects such as an increase in oil prices on an
oil drilling firm, but can
screen out market-
wide effects such as a decline in interest
rates.
46
According to
Himmelberg and
Hubbard, the reluctance to filter out market
effects is due to the
scarcity of talented
managers.
47
They find evidence that CEO
remuneration is
positively correlated with
market returns especially in large firms. They
argue that
this evidence can be explained by
inelasticity in the supply of individuals
qualified to
run large firms. Thus companies
need to pay more to retain them. Thus, allowing
stock option rewards to increase with
increasing market levels during boom periods
responds to this need. However, according to
Bebchuk, Fried and Walker, executives
are
unlikely to take a new job outside their current
industry.
48
If such a move is
unlikely, executive pay need not be tied to
broader market movements. In addition,
since
renegotiation of salary is possible, it makes
sense for a firm to pay the
executives with
options that screen out sector and broader market
rises.
45 Janakiraman, Surya, Richard A. Lambert, and
David F. Larcker, 1992, An empirical investigation
of the relative
performance evaluation
hypothesis, Journal of Accounting Research
30,
53-69.
46 Levinshon, A. (2001).”A Garden of
stock
options helps harvest talent”, Strategic
Finance, 82, 8, 30-38.
47 Charles P.
Himmelberg & R. Glenn Hubbard & Darius Palia,
2000.
Understanding the Determinants of
Managerial Ownership and the Link Between
Ownership and Performance,NBER Working Papers
7209,
National Bureau of Economic Research,
Inc. (1999),
48 Bebchuk, L.A.; Fried, J.M.;
Walker, D.I (2002). “Managerial Power and
Executive Compensation”, The
University of
Chicago Law Review 69, 751-785
9
Accordingly, Levmore offered a super-
risk alteration explanation for the lack of
indexing.
49
According to Levmore,
indexed options would sway managers to
differentiate their firms from the index in
order to increase the likelihood of in-
the-
money options. In return, it could cause
managers to forgo the best projects in favour
of lower-value projects that have higher
volatility. However, even if indexing affects
managers’ choice of projects, it is not clear
that indexing would generally aggravate
managers’ decision making. Similarly, ordinary
options themselves do not completely
overcome
the effects of managerial risk aversion. Managers
might still avoid some
high-value projects in
place of high-volatility projects. In such a case,
if indexing
were to affect managers’ project
choice in the manner suggested by Levmore, it
could
improve the quality of projects chosen.
It has been argued that options whose exercise
price is indexed to the sector or market
average (standard index options) would
impose
too much additional risk of non-payment on risk-
averse executives.
50
However,
according to Bebchuk & Fried, a reduced
probability of payout is not an
inevitable
consequence of indexing; in fact one could easily
design an indexed option
that has the same
probability of payout as a conventional
option.
51
It has been argued by
Jin that indexing might be futile because managers
can always
make adjustments in their pay to
offset the effect of indexing.
52
Thus a
combination of
indexed options and the
director’s market portfolio investment could
generate the
returns of a conventional option
on their firm’s stock. Given that, there is no
justification incurring transaction costs to
create indexed options in the first instance.
However, Bebchuk, Fried & Walker add that
managers can buy such a portfolio with
their
own money.
53
Not buying the portfolios
would save money the firm could make
available
to shareholders.
49 Levmore, S. (2001).“Puzzling stock options
and compensation norms”, University of
Pennsylvania Law Review,
149, 6, 1901- 1941.
50 Murphy, K. J. (2002). “Explaining executive
compensation: managerial power versus the
perceived cost of
stock options”. The
University of Chicago Law Review, 69, 3.
51
Bebchuk, L.A. and J. M. Fried. (2006). Pay without
Performance: Overview of the Issues. Academy of
Management Perspectives 20: 5-24.
52 Jin,
Li (2001), “CEO Compensation, Diversification and
Incentives,” Manuscript,
Massachusetts
Institute of Technology (January). (2001)
53
Supra 49 at 14
10
Furthermore,
there is a debate in the literature as to the
optimal exercise price of
executive stock
options.
54
Under the managerial power
approach, the uniform use of
at-the money
executive stock option plans has come under
scrutiny. It recognises that
managers are
interested in the lowest possible exercise price.
Hall argues that at-the-
money options might
well provide the best combination of high rents
and low
outrage.
55
By holding the
number of options granted constant, executives
would want
the lowest possible exercise price.
However, granting in-the-money options appear to
represent a gift. It requires no improvement
in performance and thus represents a lever
for
outrage. Furthermore, firms tend to lower the
strike prices of options when their
stock
prices fall below the original exercise prices,
and rarely raise strike price when
the market
is rising market. Such benefits constitute a
windfall. From the managerial
power
perspective, however, the resetting arrangement
makes sense. Accordingly,
when the stock price
drops, resetting can be justified as a medium for
retaining and
motivating executives as the
firm moves forward.
It must also be
recognised that corporations take few steps to
prevent the unwinding
of the incentives
provided when granting options and restricted
shares. Executives are
risk-averse, thus once
the options and restricted shares vest, they wish
to convert them
into cash. But such unwinding
undermines the incentive flowing from holding
these
instruments. It should be noted that the
justification for restricting executives’
freedom to unwind vested incentives is not
necessarily the same as the rationale for
vesting periods. The vesting period is
intended to prevent an executive from instantly
resigning and walking away with the options
without having contributed any value to
the
firm. It is thus desirable to give executive
options that vest in a period of 3 years
(in
line with board elections) but cannot be cashed
out during the two-year period.
Exercising
options immediately could mean that shareholders
must provide the
executive with new options to
maintain the same incentives or indirectly bear
the
costs associated with the executive having
weaker incentives.
54 Murphy, Kevin J. (1999)., “Executive
Compensation,” in Handbook of Labor Economics
(Orley Ashenfelter and
David Card eds.) (North
Holland: Amsterdam)
55 Hall, Brian (1999), “A
Better Way to Pay CEOs?,” in Jennifer Carpenter
and David Yermack, eds, Executive
Compensation
and Shareholder Value: Theory and Evidence 35–46
(Kluwer Academic).
11
However,
restrictions on executives’ ability to cash out
vested incentive instruments
could impose some
liquidity and diversification costs on the
executives.
56
The
absence of such
restrictions can be explained under the managerial
power approach.
Since designers of pay
packages are seeking to benefit managers, they are
not
particularly concerned by the fact that
the broad freedom to unwind incentives dilutes
the strength of these incentives. Furthermore,
a significant number of firms reload
options
to executives who exercise options by surrendering
shares.
57
The holders of
an option
with a reload provision exercises that option
before expiration and pay the
exercise price
with own shares. In return, the executive receives
the underlying shares
optioned, plus a new
option for each share tendered in exercising the
options. The
reloaded options would have the
same expiration date as the original; but the
exercise
price will be at the market rate.
Indeed, options with a reload provision are worth
more to the holder than conventional
options.
58
However, proponents such as
Guay
59
argue that reload encourages
executives to exercise options earlier and
therefore to
hold more shares.
Another common remuneration practice is use of
gratuitous payments, mainly to
facilitate
company acquisition; a payment sometimes not
contracted for.
60
Managers
enjoy
private benefits of control over the firm and have
an incentive to resist
takeovers, even if the
takeover would benefit the company. Contracts can
provide for
such payments through what is
called a golden parachute. Choi argued that golden
parachutes encourage managers to take
desirable risks.
61
In addition,
Subramaniam
argued that golden parachutes
reduce the disciplining effect of the market for
corporate control on managers.
62
However, gratuitous payments are explained under
the managerial power approach. According to
the theory, since a CEO can delay or
56 Schizer, David M. “Executives and Hedging:
The Fragile Foundation of Incentive
Compatibility.” Columbia Law
Review 100
(2000c): 440-504.
57 Reingold, J. 1998.
Executive Pay, Business Week: 2.
58 Hemmer,
T., Matsunaga, S., & Shevlin, T. 1996. The
influence of risk diversification on the early
exercise of
employee stock options by
executive officers. Journal of Accounting &
Economics, 21: 45-69.
59 Guay, W. 1999. The
sensitivity of CEO wealth to equity risk: An
analysis of the magnitude and determinants.
Journal of Financial Economics, 53: 43-71.
60 Hartzell, J.C., Ofek, E., and Yermack, D.,
2004, What’s in it for me? CEOs whose firms are
acquired, Review of
Financial Studies 17,
37-61.
61 Choi, A., “Golden Parachute as a
Compensation-Shifting Mechanism.” Journal of Law
Economics &
Organization, 2004, Vol. 20, pp.
170-191
62 Subramaniam, C., “Are Golden
Parachutes an Optimal Contracting Response or
Evidence of
Managerial Entrenchment?:
Evidence from Successful Takeovers.,” Journal of
Business Finance & Accounting,
2001, Vol. 28,
pp. 1-36.
12
prevent desirable
acquisitions, the board might find it necessary to
bribe the CEO to
allow the acquisition to go
forward smoothly or as a personal gratitude for
stepping
aside. Given the aforementioned, the
managerial power approach affirms that
managers will extract more rents in positions
of greater power such as during
takeovers.
Given the aforementioned, it is difficult
to believe that such a blunt tool (the market)
could align the interests of the two competing
forces. Money remains the main
motivator and
schemes like stock option only exacerbate the risk
of managers but do
not necessarily change the
mindset. And if aligned, it is questionable
whether
corporate interests will be served by
professional managers who view rising share
price as the ultimate reward. Because boards
cannot be relied on to negotiate optimal
contracts with executives, institutional
investors need to pressure organisations to stop
using some of the conventional practices that
appear to be sub-optimal. In this regard,
the
optimal contracting approach predicts that the
evolution of executive
compensation over time,
although slowed down by the tendency to follow
established
practices, would be largely shaped
by the forces of optimal contracting. In contrast,
the managerial power approach predicts that
the evolution of executive compensation
over
time would be shaped at least in part by the
desire of executives to extract more
rents
from their firms.
While an examination
the market’s ability to bring fairness in
remuneration practices
in public companies has
left it trailing behind managerial power, most of
the
criticisms should be levied at Salomon.
The 20
th
century decision affirmed the
doctrine of corporate personality which
resulted in a divorce between ownership and
control.
63
It has served society with
capitalism which has increased individual wealth,
research and development, as well as
availability of goods and services. The
separation between ownership and control has
largely left shareholders, who are
restricted
from intervening in company operations, at the
mercy of executives who are
unconvincingly
being disciplined by the market. From such an
observation, one is
safe to conclude that
performance related pay is inherently flawed. To
combat the
scourge of unrestrained executive
greed, the Financial Services Authority (FSA)
63 A. A. Berle, and Means, G. C. (1932) The
Modern Corporation and Private Property. New York:
Commerce
Clearing House
13
carried out a review of remuneration
practices of 22 financial services firms UK in
2009, prompted the UK government intervention
in 2008 to save Halifax and Royal
Bank of
Scotland.
64
Their excessive remuneration
packages left the FSA concerned
that
remuneration approaches were hindering company
profitability, economic
development and the
least, self-indulgent. In its report, the FSA
highlighted that
unadjusted net revenue
provided a poor metric for measuring performance.
Managers
were more intertwined with short-term
gain, thus hindering the long-term future. They
recommended risk discounted profits when
calculating bonuses.
The FSA has a
remuneration code stringently regulates the
remuneration practices of
listed
companies.
65
It is not strictly ‘comply or
explain’ rather, it is in their handbook.
Administrative sanctions and possible
delisting can be levied on companies that fail to
comply. An issue pointed out by the Financial
Stability Forum (FSF), a global
supervisory
and regulatory infrastructure, most boards of
financial services
institutions view
compensation systems as largely unrelated to risk
management and
risk governance.
66
It
recommended banks and other organisations to align
remuneration with risk management. Henceforth
came the Walker Review (specific to
banks)
suggesting that incentives should be balanced so
that at least one-half of
variable
remuneration offered in respect of a financial
year is in the form of a long-
term incentive
scheme with vesting subject to a performance
condition with half of
the award vesting after
three years and of the remainder after five
years.
67
The Walker
Review also
recommended that banks should disclose bands of
pay so that the public
knows the high earners.
The Walker Review wanted short-term bonus rewards
to be
paid over a three-year period with no
more than one-third in the first year and
clawback to be used as the means to reclaim
amounts in limited circumstances of
misstatement and misconduct. Most of the
reforms proposed by the Walker Review
were
made in the 2010 UK corporate governance
code,
68
including a stewardship
code
to enable institutional shareholders to become
more vigilant activists.
69
The
64 Financial Services Authority, Reforming
Remuneration Practices in Financial Services,
Consultation Paper
0910 (March 2009).
65
FSA Remuneration Code:
http:twhatinternationalremuneration (Accessed
8022012)
66 FSF:
http: (Accessed 18032012)
FSF Principles for Sound Compensation
Practices 2nd April 2009. http:licationsr_
(Accessed 28032012)
67 The Walker Review of
Corporate Governance in UK Banks, HM Treasury,
July 2009, 8-13
68 Corporate Governance Code:
http: (Accessed 19032012)
69 Stewardship
Code:
http: (Accessed 18032012)
14
reforms also include a group and code
for remuneration consultants who tend to lack
independent judgement when determining
remuneration levels.
70
Since in
banks, remuneration forms a significant proportion
of the overall annual
costs, recent Financial
Reporting Council (FRC) recommendations seek to
create a
link between remuneration and risk
policy, aligning such remuneration with long-term
company success and off-course not subjecting
non executive directors to market
related
remuneration. Given such recommendations, adjusted
risk will ensure that
future loses are
accounted for and a bank’s liquidity will not be
damaged. There is
also a need to ensure that
at least one member of the remuneration committee
has
experience of risk issues. Judging from
the aforementioned, forward looking
disclosure
and limiting short term incentives is a good step
forward.
Theoretically, the ‘comply or
explain’ approach to the UK corporate governance
code
could potentially undermine any of the
proposed changes to the so called reward for
failure culture.
71
It is yet another
example of the reluctance of courts to intervene
in
the management of companies. Although the
market price of a company could
potentially
suffer if a company does not comply, it must be
practiced by nearly all
companies for it to
have an impact on the non-confirming company.
Furthermore,
complexities of modern finance
and information asymmetry leave management with
incentives to undertake risky venture where
ultimately the regulator is a step behind
the
managers. Pay arrangements are also a lever for
risk taking thus regulators should
aim to
increase capital requirements of companies
exhibiting risky arrangements.
Executive
contracts that guarantee large severance payment
should also be subject to
review. However,
executive contracts vary to reflect a particular
company or job and
thus an attempt to regulate
severance payment could undermine this
flexibility.
Although remuneration committees
are empowered to review such contracts, in
practice they are incapable.
Given
that the ‘comply or explain’ approach has largely
been ineffective in curbing
inefficient pay
arrangements that are designed to camouflage the
extraction of rent
70 Remuneration consultant code : Remuneration
Consultants Group (Accessed 19032012)
71
MacNeil, I. and X. Li (2006) Comply or Explain':
market discipline and noncompliance with the
Combined Code;
Corporate Governance: An
International Review 14(5): 486-496
15
and which provide sub-optimal or even
adverse incentives, then the law must toughen
up. Since exorbitant pay packages remain the
norm in UK, those in Westminster must
aim to
strike a balance between a corporate friendly
environment and a legal
framework that does
not hinder innovation as in Consultants Ltd v
Cooley but
restrains rent extraction and
provides a degree of control to shareholders.
Immaterial
of the recent perfunctory legal
developments, the future follows the view of
managerial power, with lax regulation and a
culture of rewarding for failure; which is
an
inherent corollary of capitalism. History has
shown that the unwillingness of
lawmakers to
question the veracity of executive pay is
essential for prolonging
capitalism through
innovation and wealth creation which attracts the
best managers.
Having examined the
theoretical, practical and legal approach to
executive
remuneration, it is clear that the
government has intensified the process of
regulating
predominantly the banking sector in
order to avert any awaiting disasters. The current
remuneration practices undermine the orthodox
principle which provides that levels of
pay
should be sufficient to attract, retain and
motivate directors. However, the
government
still harbours the view that the ability to
compete and secure the best
managerial talent
is essential for the future of UK businesses, thus
the UK should be a
fertile ground for
entrepreneurial activity and innovation not one of
fairness and
equity. And why not, given that
it falls well within the ambit if its manifesto,
however, questions must be asked on whether we
are sacrificing stringent regulation
in order
to remain competitive with uprising powers like
China. The US responded to
such overwhelming
logic with Sarbanes Oxley 2002 and not for the
first time, the UK
followed suit with the
Enterprise Act 2003 and the Companies Act 2006.
Did the
desire to build an empire of debt
driven companies contribute to the economic
crisis?
Possibly! But one thing is clear,
there remains tension between economic and legal
scholarship in this area. This tension is
rooted in the 1897 House of Lord decision in
Salomon, which continues to stir forward
capitalism at the expense of equity and
fairness in the market. Whether the Walker led
reforms will manifest into possible
deterrents
to excessive remuneration in the banking sector or
mere paper tigers, time
will tell.
16