Encouraging achievement of stakeholder objectives
In most private and public organisations, the managers that are involved in the organisations on a daily basis are not the owners of the firm rather they manage on behalf of the owner. Ensuring the directors aim towards achieving the stakeholder objectives is met is important and using the right incentives may encourage goal congruence. However directors could act in a non-goal congruent manner involving creative accounting, setting high salary levels or off-balance-sheet financing this is known as the Agency problem.
Agency & Principal Theory
Ensuring that financial managers make decisions benefiting shareholders is important because shareholders are the owners of the company and they expect a return from investments. The Agency problem is where the shareholders (principal), expect their directors (agents) to make the decisions that will maximise shareholders wealth but instead the directors will work towards their own needs such as giving themselves high salaries or perks.
For example, the UK recession in the early 1990s and the economic slowdown in 2002-2003 led to companies reporting reduced profits and cutting levels of employees and employee’s pay while directors were still getting significant bonuses. The incentives that can be introduced to encourage goal congruence are reward schemes such as Performance-related pay, Shares and Share options.
Corporate Governance & Stock Exchange
Encouraging achievement of stakeholder objectives can also be done using regulatory requirements, such as corporate governance and stock exchange listing regulations.
Corporate Governance is the system by which organisations are directed and controlled. The key elements of Corporate Governance are CREAM:
- Culture issues
- Ethical decisions
An example of a code of good practice:
- Board should be responsible for major policy & strategic decisions
- Directors should possess mix of skills – assess their performance regularly
- Separate roles of chairman & chief executive
- Directors’ remuneration set by remuneration committee (independent NED’s)
- Remuneration dependent on organisation & personal performance
- Full disclosure of remuneration policy & individual packages
- Regular dialogue between Board & shareholders
- Annual report confirming governance regulations & codes complied with – giving specific disclosures about the Board, internal control reviews, going concern status & relations with stakeholders.
The Stock Exchange listing regulation ensures stock markets operate in a fair and efficient manner, meeting certain listing requirements is required, such as:
- Listed companies must publish reports on directors’ remuneration
- Individual pay packages must be disclosed
- Justification for compensation packages
- Must compare packages with company performance
- Report must be voted on by shareholders