Acc307 Accounting Theory Assessment Answers

Making managerial pay contingent on measures of managerial and/or firm performance motivates them to deliver good performance for shareholders. However, it also burdens them with greater risks than they may like. How do organisations balance these two considerations when choosing managerial pay and performance measures?

Obtain the remuneration report for a publicly listed company. Examine the compensation contract for the chief executive officer (CEO). Prepare a report which summarises your findings relating to the following issues:

(a)What amount is short-term in nature (salary and cash bonus) and what is based on long-term firm or managerial performance?

(b)What proportion of the CEO’s pay is performance based, and what proportion is not?

(c)What measures of accounting performance are used to determine the CEO’s bonus?

(d)Given the accounting firm performance measures in the contract, what accounting decisions could the CEO might make in order to maximise their bonus?

(e)Can agency theory provide an explanation for the various remuneration components? Justify your answer.

Bonus plans are used to reduce agency problems that exist between managers and shareholders. Discuss two (2) of these problems specific to the relationship between shareholders and managers and identify how bonus plans can be used to reduce the agency problems you have identified. In your answer you should provide examples of specific components that should be added to a bonus contract to address the issues identified.

Accounting theory.

Question 1

It is marked that making the managerial pay depending on measures of managerial and / or firm performance definitely encourages the personnel to convey good performance to stakeholders. It truly builds up team spirit among the team affiliates to achieving the greater productivity and reach its objectives. Performance based pay encourages personnel as it makes their work rewarding and interesting. Nevertheless these may create a series of unintended consequences. Huge fiscal incentives causes’ unpremeditated risk and occasionally counterproductive outcomes, it is tough to satisfactorily stipulate precisely what individuals ought to do and thus how their performance should be measured.

One of the unpremeditated result caused by performance based pay might be on relationships and teamwork. Relationships amongst workforces can be causalities of scramble for payments. If the work necessitates teamwork, hitherto personnel are rewarded centered on individuals as contrasting to team output then this will reduce the performance (Shi 2017). In this situation the company can evade the risk by being fair. Fairness has an important connection with the co-operation. Cautious management and implementation of performance centered pay can lead to affirmative results.

One more unpremeditated result is ethics and quality. Using greatly precise individual performance incentives and assessment with occupations that are multipart, inter-reliant and have numerous and unstructured goals can effect in personnel and management disregarding vital facets of their work and interfere with performance in order to meet goals set (Dominici 2017). The personnel might stress quantity over quality. Hence, when designing sustainable linked reward systems, it is essential to make sure the conditions used for performance appraisal is well-managed and monitored. This will ensure suitable managerial pay and deliverance of good performance to shareholders.

Question 2

This report is based on the Snam’s Remuneration report of 2017. Short-term variable incentive is provided yearly in monetary form. It is an implement that is useful in inspiring and directing management’s accomplishment in short term, in link with the company targets set by the Board of Directors. The quantity of short-term incentives hinge on the position held and corporation individual performance outcomes. The criteria for implementations are;

Corporate/ CEO: Investments (20%), Operational Efficiency (30%)

Expansion of non-regulated events (10%), Sustainability (accident occurrence index for staffs and contract personnel (10%), free cash flow (30%)

DIRS Targets: the Annual monetary incentive is calculated at 50% from the outcomes of the target allocated to the CEO and, for the residual 50% from specific targets focused on financial, operating and work performance.

The incentives provided depend on the outcomes attained in the preceding year and assessed according to a performance gauge of 70/130 points, with least level for incentives equivalent to a general performance of 85%. CEO short term value are 50% of the fixed payment for outcomes of the corporate structure equivalent to the target score= 100; 65% of the fixed payment equivalent to the max score=130. The long term variable incentive is kept for those holding position with the utmost direct accountability for company outcomes, guarantees better alignment between the actions management and interest of stakeholders.

The CEO fixed pay which is not based on performance is which is about 75% and € 150,000 which is about 25% which is based on performance. The CEO yearly bonus is calculated with reference to target incentive level (performance= 100) and a supreme level (performance 130) correspondingly equivalent to 50% and 65% of the fixed remuneration in association with the outcomes accomplished in preceding year compared with target defined. The accounting decision that the CEO might make to increase their bonus is to increase employees salary based on performance this will motivate workers hence maximize performance hence their bonus will increase.

The agency theory can give an explanation for the remuneration components. Agency theory is used to plan the incentives suitably by considering what interest motivates the manager to act. Incentives encouraging corrupt behavior are removed and rules discouraging ethical risk are placed. This increases the financial gains which in turn increases the compensations.

Question 3

The parting of control and ownership means that executives can act in their personal concern, that maybe differing to the interest of investors. This can be classified into number of particular problems (Khoso 2018):

Risk aversion problem. Executives desire lesser risk than stakeholders since their human capital is tied to the Company. They favor to diversify their personal risk fairly than maximizing the rate of the Company by risk ventures.

Dividend retention problem. Executives select to fee out less of the company’s incomes in bonuses in order to wage for their personal advantages.

Horizon problem. Executives are only concerned in money flows influencing their payment for the time they stay with the company, while stakeholders have a longstanding concern in the company’s money flows since stake values equal the existing value of stakeholders’ prospects of all future money flows.

Bonus plans may be used in different ways to reduce these problems. To lessen horizon problem lasting pluses such as stakes or preferences are suitable, as it inspires executives to advance lasting performance, and also take a long-standing devotion (Pepper 2015). Binding a higher percentage of executive wage to share price movement, using proportions such as total stakeholder return, primarily as the managers tactics superannuation is also expected to hearten executives to exploit lasting performance. Relating bonuses to seek out extra profits, which in turn are going to be available for dividend, thus lessening the dividend retention problem. Including incentives to hearten managers to invest in more risky projects can reduce the risk aversion problem (Bosse 2016).

Question 4

 Lending in the recession or economic downturn period is somewhat very challenging and risky since in this period individuals loses their work and businessmen get into losses in their companies. So the lending at this time can be very risky to the bank (Becker 2017). Simple covenants are sensibly effective in decreasing financial agency problems and therefore help the bank acquire the benefits of debt financing. Nevertheless the net benefit achieved from debt financing will finally be contingent on the nature of the covenant restriction, and the ability to suitably implement them. The bank must be concerned with the risk aversion problems and horizon problems. Accounting provides information on the dynamics and structure of corporation’s wealth, financial position and outcomes. Accounting information delivered is envisioned for both external and internal users (Cascino 2017). The accounting information will help the company’s management, which is the internal users, to base judgment and long and short term plans, essential to accomplish their aims.

References

Becker B, Ivashina V. Financial repression in the European Sovereign debt crisis. Review of Finance. 2017

Bosse DA. And Phillips, R.A. Agency theory and bounded self-interest. Academy of Management Review, 41(2), pp.276-297.

Cascino S, Clatworthy M, Garcia Osma B, Gassen J, Imam S. 2017. The Usefulness of Financial Accounting Information: Evidence from the Field.

Dominici, G., Yolles, M. and Caputo, F., 2017. Decoding the dynamics of value concretions in consumer tribes: An agency theory approach. Cybernetics and systems, 48(2), pp84-101.

Khoso, I, Shaikh M, Parmar V, and Bashir, A., 2018. Escalating Behavior to losing projects. Agency theory Perspective. Grassroots, 48(1).

Pepper, A. and Gore, J., 2015. Behavioral agency theory: New Foundations for theorizing about executive compensation. Journal of management, 41(4), pp.1045-1068

Shi, W., Connelly, B.L and Hoskisson, R.E., 2017.External corporate governance and financial fraud: cognitive evaluation theory insights on agency theory prescriptions. Strategic management journal, 38(6) pp.1268-1286.