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You have just started working at the Sunnyside Company.
The chairperson of the board has a degree in economics and agency theory has guided the determination of executive compensation.
Executives receive compensation comprising salary and performance bonuses.
The recent departure of two executives has resulted in discussions by board members about the effectiveness of the current compensation system in motivating and retaining the executives. In their exit interview one of the executives commented that the CEO was difficult to work with as he lacked empathy and was a bully.
You have been asked to prepare a report to the board about executive compensation. To compile this report you will need to analyse the existing approaches and consider the findings of research about executive compensation.
Several questions have been asked at board meetings about executive compensation. One member of the board asked, 'Is it appropriate to use the same proportions of different benefits for each of our key executives, when they appear to have very different personalities and motivations?' Another asked why there was a large difference between the CEO's compensation and the other executives. Issues were also raised about hiring a compensation consultant and establishing a compensation committee. One of the directors recommended their cousin, who recently graduated with an MBA as an ideal choice for the compensation consultant.
The four key executives whose compensation needs to be determined are:
Mr Bill Syme CEO. Bill has been the CEO for 10 years. Sixty years old, he is very charismatic and visionary. During the 2009 financial crisis Bill led restructuring of the company that saw the retrenchment of 50 employees. Since then Bill has been instrumental in growing the company through two acquisitions.
Dr Kate Selling, the CFO, is 35 years of age. She recently joined the company and is a qualified financial planner.
Mr We Lu, is 42 and recently immigrated from China where he worked in a similar role.
Ms Sarah Jones, CIO has been with the company 12 years and is 57. She has a Bachelor of Computing.
Your report to the board should contain the following:
General format and presentation criteria
Use the two papers about the audit expectation gap, set in two culturally different countries (these will be available on the study desk on June 1, 2015).
Compare and contrast (what are the commonalities and differences) between the two papers with relation to the following issues:
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This report is focusing on the issues relating to designing of executive compensation under an agency theory. This report provides recommendations for the most suitable approach to the board. Visibly there are certain issues as were raised at the board meeting. These issues are:
The compensation plan has to be designed for the top line executives such as CEO, CIO etc. with varying experiences, age and job responsibilities. The report primarily focuses upon the executive compensation design as directed by the agency theory, assumptions of the theory as followed designing compensations and ongoing research challenging the assumptions.
In corporate finance and governance, literature agency theory addresses the conflict of interest for different parties having a claim on assets. There are principals (debt holders and equity holders) as well as agents (executives). The conflict of interest can either between principals (large shareholders and small shareholders or equity holders and debt holders) or between principal and agents. Agency theory deals with the goal alignment of different principal to avoid the conflict of interest (agency problem). Agency theory also deals with the risk-bearing issues of principal and agents after designing the compensation for the agents.
To reduce the conflict of interest between principal and agents, the executive compensation is designed in such a way so that the agent's objective function is aligned with the principal's goal an agent works for the firm by avoiding the self-interest actions. One most prevailed way is to provide ESOP (employee stock options) to its executives.