Corporate Governance & Executive Compensation

7/29/2019 Corporate Governance & Executive Compensation

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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.


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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


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Devices for Containing Agency

Costs -Internal Devices. Internal monitoring: Performance monitoring

and responsibility accounting.Worker>Low

Level Mgr> Middle Level Mgr>Top Level

Mgr>Board of Directors.

Incentive Compensation Contracts. To make

interests more congruent, managerial

compensation may be linked to shareholdersreturns. Stock Option, performance bonuses

(sometimes) reduce agency costs.


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External Devices. Market for Corporate Control: when internal

control do not work, the market forcorporate control may act as a deterrent onmanagerial behavior that dissipatesshareholder value. Also referred to as the

takeover market, it is a market in which theright to control represented by a chunk ofequity holding that is sufficient to wield

control- is traded. Proponents of takeoverargue that an active market for control is agood external disciplining device. Helps inrescuing hapless shareholders from the

clutches of inept management.


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Managerial Labour Market: Reputation and

track record of a manager. Market can make a

manager pay a price for self-serving behavior.However it is difficult to isolate the effect of

managerial action from other influences

which shape a firms performance.


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Corporate Governance in

Industrially Developed WorldAnglo-american Model

Individual and Institutional Investors.

Professional Managers who havenegligible stake.Typical executive

considers himself John Wayne (Seathji),

wielding complete control.

Myopic outlook of institutional investorsbuilds pressure on management to report

good earnings performance in the short

run.


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A small and growing number of

investors are playing an active role in

corporate governance. Tight disclosure norms, insider trading

laws, stiff penalties for price

manipulation.Active market for corporate control

providing credible threat of take over.


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German-Japanese Model

Banks and financial institutions have

substantial stakes in the equity capital ofthe companies.

They play an active role in the

management of the firms.

Disclosure norms are not too stringent.

Checks on insider trading is not too high,

impairing on the efficiency of the capital

markets.


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Corporate Governance in India

Management by chromosomes. Entrenched System

In the public sector

Transient system with key players, viz,politicians, bureaucrats, and mangers

taking a myopic view of things.


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Reforming Corporate

Governance Strengthen the hands of Institutional

Investors.

Separate Management from Control

Management Control

Initiation Ratification

Implementation Monitoring

under Chairman Under MD


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Expand the Role of Non-executive

Directors.

Limit the Size of the Board. Ensure that the board is Informationally

well equipped.

Link Managerial compensation toperformance.

Enhance Contestability.

Cumulative Voting system

Improve Corporate Accounting and

Reporting Practices.


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Goldman Sachs Group, Inc

Introduction:effective functioning of theBoard and its committees, to promote

the interests of stockholders, and to

ensure a common set of expectations

as to how the Board, its various

committees, individual directors and

management should perform their

functions.


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Assignment

Read the handout pay special attention to

VI. The Committees of the Board


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Legal Provisions v/s CII code Companies Act 1956

Limited co must have at least 3 directorsBoard must meet at lease once in a quarter

No person can be a director of more than 20 cos.

BoD have power to a)borrow,lend,invest

b)declare dividends c) Appoint MD

Total remuneration of the directors is subject to aceiling of 11% of net profits.Sitting fees subjectto some limits.

BOD has a duty to present the Annual Report tothe members.

BOD punishable for breach of trust, dishonesty

and fraud.


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CII Code In an attempt to improve the quality of

corporate governance, CII has suggested a

code for its members.


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Executive Compensation Key elements of Executive compensation in India

are salary, benefits and incentive compensation.

Benefits include furnished accommodation,

pension and gratuity benefits, chauffer driven car,

medical reimbursement, club membership, LTA andso on.

Incentive compensation is typically in the form of

an annual bonus which is linked to performance

measured commonly in terms of certain accountingnumbers. Occasionally it is In the form of stock

options or reward of shares.


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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 capitalmarket. Managers, on the other hand are not

inclined to accept high firm- 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.


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Failure of Executive Compensation Plans to

Promote Value Creation.

Linkage between size and pay. Emphasis on short term performance.

Reliance on accounting measures which are

poor proxies for value creation.


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Designing an Incentive Compensation

Plan

A well conceived incentive compensation

plan goes a long way in aligning the interests

of managers and shareholders.

Integrate the Incentive plan into the totalcompensation Architecture.

Choose the Appropriate Level of Risk Posture

and Time Focus.Use Objective criteria

Select the right set of performance measures.

Reward relative measures.


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Discourage parochial behavior.

Abandon attempts to measure what

executives control. Lengthen the Decision making Horizon of

the Executives.

Employ Stock Options Judiciously.

Ensure tax Efficiency.


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ESOP Eligibility

Not a promoter, not a director who holds morethan 10% of the outstanding Equity Shares.

Compensation committee consisting of a

majority of independent directors, for advice andsupervision of the ESO scheme.

No ESOS unless shareholders pass a special

resolution.

Pricing

Lock in period and rights of the option holder.

Corporate Governance & Executive Compensation

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