Session 9.
Remuneration and Institutional Shareholders
Individual Assignment
Review Questions (1)
1. Discuss the advantages and disadvantages of each of the following remuneration
components: Base salary, Bonuses, Stock Options, Restricted share plans (stock
grants), Pension (superannuation)?
A. Base Salary:
Advantage: Guaranteed sum of money
Disadvantage: Is not related either to the performance of the company
nor to the performance of the individual director.
B. Bonuses:
Advantage: Dependent on performance
Disadvantages: One’s performance very often is uncontrollable
Short-term orientation
Take unnecessary risks.
C. Stock Options:
Advantage: A simple means of linking remuneration to performance.
Disadvantages: Has a limitation to performance-based exercising
Has a limitation to stipulated holding period
Has a limitation to the fluctuation of the stock price.
D. Restricted Share Plans (Stock Grants):
Advantages: Stock grants require no payments to the company.
Broader criteria used rather than share price.
Disadvantage: Shares are taxable as income at the time of vesting.
E. Pension (Superannuation):
Advantage: Encourages long-term employment within company
Disadvantage: Important to suit one’s needs.
2. How does remuneration attempt to address the principal-agent problem?
Shareholders have increasingly sought to use equity-based incentives, in the hope
that ensuring that a large bulk of executives remuneration is in the form of – or
linked to – the company’s stock will encourage their agents to act very deliberately
and clearly in the long-term interests of shareholders as a whole, rather than in their
own interest. Remuneration attempt to address the principal-agent problem is
proposes an “incentive alignment” between the hired managers and the owners’
interest to reduce principal-agent problem. Agents should be rewarded for results
that are deemed to be in the interest of owners. Board of directors use pay to align
managers’ interests with shareholders’ interests via the use of incentive
compensation.
3. How are board committees (i.e remuneration committee) structured to help
address principal-agent problems?
The structure of the remuneration committee helps prevent executive directors from
setting their own remunerations levels. This helps address principle-agents problems
because if the remuneration was left in charge of executive directors they would act
in their own self-interests and increase their remuneration.
Review Questions (2)
4. Who are institutional investors? What role may institutional investors play in the
corporate governance?
Institutional investors are generally the large investors. They comprise mainly
pension funds, insurance companies, bank/unit trusts and foundations. Advantage of
institutional investors are well resourced, access to industry experts, good proxies
for the public interest.
5. Should institutional investors be required to vote the shares they control? What
might some of the impediments to voting be institutional investors (shareholders)?
Yes, because institutional investors have a responsibility to make considered use of
their votes as it is a powerful and public means of exercising voice.
Impediments to voting:
Communications Problems (Language)
Box-Ticking Mentality.
Overseas Voting (Form, Arrangement of Proxies, Timing Problems and
Language Difficulties)
Institutional Reticence
Review Questions (3)
6. Discuss the ‘tools of governance’ institutional investors have at their disposal:
A. One-to-one meetings
The meetings between institutional investors and companies are extremely
important as a means of communication between the two parties. The issues
that are most discussed are areas of the firm's strategy and how the firm is
planning to achieve its objectives, whether objectives are being met, the quality
of management, etc. Purpose of the meetings:
Institutional investors fully understand the firm's business and strategy,
so that the value of the business is fully recognized.
Institutional investors may in turn use such meetings to investigate
company governance practice.
B. Voting
Voting is the right to vote (attached to voting shares).
Institutional investors should make positive use of their voting rights and
disclose their policies on voting.
Voting is the fundamental element of control by shareholders.
Methods of voting include: in person, by post and through a proxy
C. Shareholder Proposals/Resolutions
Shareholder proposals are often in relation to social, environmental, ethical
issues or dissatisfaction with exEcutive remuneration packages. Voice in changing
the company.
D. Focus Lists
A number of institutional investors have established focus lists, whereby they
target underperforming companies and include them on a list of companies that
have underperformed a main index. Underperforming the index would be a first
point of identification; other factors would include not responding appropriately
to the institutional investor's enquiries regarding underperformance, and not
taking account of the institutional investor's views. After being put on the focus
list, companies receive unwanted attention of the institutional investors who
may seek to change various directors on the board.
E. Corporate Governance Rating Systems
A powerful indicator that shows a company or country's current
corporate governance standards.
Two professional rating systems: Deminor and S&P.
Useful to governments and firms management in understanding their
corporate governance level compared to other countries, or companies.
Good corporate governance is generally perceived as more attractive
than without.
