A3 Corporate Governance and Executive Pay
Corporate governance refers to the rules and process that govern the way in which an organisation is managed. The Board of Directors make key decisions to balance the need of their various stakeholders including shareholders, customers, employees and the community.
Executive pay refers to the methods of payment received by the top level management of an organisation. This includes their salary and additional benefits such as annual bonuses, shares in the company, insurance, club memberships and retirement packages. Various ethical issues have been raised in relation to executive pay such as the large gap between executive and employee pay packages. Incentivising executives to meet profit targets can also create a conflict between profitable and ethical decisions.
Divorce of ownership and control. In larger businesses, the owners are not involved in the day-to-day decision-making of that business. The Board of Directors makes the larger, strategic decisions and managers make day-to-day decisions for their area of responsibility. Directors and managers will be incentivised to meet the needs of the shareholders, follow corporate governance procedures and relevant laws. It is important that decision-makers have the requisite skills to act on behalf of the owners of the company.
There is a division of responsibilities when appointing directors and managers. For example, directors may be appointed for each of the main functional areas such as Finance, Marketing and Operations. Directors may also be appointed for geographical areas or products.
The principal agent problem is the conflict of interest that exists between acting for the benefit of one’s self and the interests of others. In corporate governance, managers are appointed as agents to act on behalf of shareholders. When manager and shareholder objectives differ, there is a risk of managers acting in their own interest. It is difficult for shareholders to monitor due to lack of information on day to day operations.
Attempts to identify risks of the principal-agent problem include;
Recruitment measures to ensure the integrity of managers. This may include discussing objectives at interviews, checking references from a range of professional acquaintances, and psychometric testing.
Performance-related incentives that focus on whether the needs of stakeholders are met can reduce the conflict faced by managers.
Internal checks and control on the activities of managers can uncover conflicts much earlier. This can also highlight to managers the importance of meeting the stakeholder needs on a regular basis.
Remuneration committees develop reward policies that focus on the long-term goals of shareholders. They develop the terms and conditions of executive employment to give clarity of expectations and ensure that managers are clear on how their conduct can meet both their individual needs and the needs of their shareholders.
