Accounting Based Executive Compensation Plans in Australia – An Analysis
Department of ABC, University of XYZ
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Introduction
Executive compensation plans are an imperative component of an organization’s entire business tactic. In directing an organization to higher altitude of accomplishment, Chief Executive Officers (CEOs) and higher-level executives are vital building blocks. A large number of companies contain discrete executive pay plans and such plans concentrate more on the particular person, where the compensation package is personalized for this individual. However, the packages for executive pay should be steady with the organization’s compensation attitude. They should be feasible with other similar officers surrounded by the similar business and also equivalent sized companies. In addition, accounting based executive compensation plans are utilized by a great proportion of organizations. And such plans which are based on accounting based performance objectives formed a great share of executive reward. In the contemporary times, a good deal of the public interest has paid attention on the rising compensation for CEOs with an amplified discrepancy in rewards between high level executives and lower level workers.
The purpose of this report is to significantly scrutinize the use of accounting-based executive compensation plans. By capitalization, the financial division is the prevalent industry division in Australia. An analysis of executive compensation of four companies namely Commonwealth Bank, Westpac, ANZ, and National Australia Bank is presented. These companies are listed on the Australian Securities Exchange (ASX). A range of issues in their executive compensation plans is also discussed.
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Accounting-based Executive Compensation Plans with Share Market Based Reward Systems
In essence, an executive compensation plan is an agreement between the organization and its executives that makes an effort to line up the interests of owners and executives (Conyon 2006). Even though these compensation plans are coherent with the forecasts of agency theory, they are much more intricate as they include a blend of incentive, threat, and decision perspective considerations. The concept of executive compensation signifies that there are a number of features that should be taken into account when developing an executive compensation plan, like competence, accounting net income in opposition to share price, agency costs, decision perspective, and threat.
The association between salary and performance is a resulting factor of agency theory (Fattorusso 2006). In proportion to the models, compensation plans must be planned to line up the interests of risk- reluctant self-absorbed executives with those of shareholders. In the last twenty years, the theoretical study on agency theory as well as executive compensation has different views. According to the literature, executive compensation plan should be associated to the performance of an organization (Jensen & Murphy 1990). It has also come into view that elected officials and the media have conflicted that existing executive compensation practices impel workers to take short-term risks with little interest for the long-term consequence on their organizations.
A well-organized compensation plan denotes that there is a strong association between the efforts made by the executives and the reward obtained from the compensation plan (Cheng, 2004). However, according to Jensen and Murphy (1990), very low correlation was found between an executive’s performance and compensation. One approach of assessing executive’s effort is by means of accounting-based measures like net income. One strong point for utilizing net income involves the fact that it is more consistent, since it is derived from historical cost, and it is less unpredictable with regard to economic measures (Bryan et al. 2000). Yet, this accounting-based measure is not well-timed for the reason that an executive decision possibly will create both short-term as well as long-term consequences and simply some of the payoffs might be incorporated in latest net income. It is analyzed that one main issue with compensation agreement outline is that the entire influence on net income of existing executive effort is generally not visible early enough to shape the foundation of incentive agreement. The payoff issue is even superior if it is identified that executive effort is an array of activities, instead of a particular action. Also, some of these activities encompass longer-run consequences as compare to others.
On the basis of such issues, share price might be a superior measure as it appropriately indicates publicly accessible information, considers potential payoffs from existing executive actions, and completely integrates the information of net income. On the other hand, it involves economy-wide aspects too that are out of an executive’s control and is extremely unpredictable. By means of well-organized securities markets, share prices will appropriately indicate all that is identified concerning probable payoffs from existing executive activities (Beatty et al. 1996). Share price, a market based measure, incorporates the information matter of net income itself. Nevertheless, share price is influenced via economy-wide measures, for instance, changes in interest rate. In addition, the existence of noise traders indicates that share price does not completely combine public information. For that reason, the utilization of share price as a payoff measure possibly will inflict more risks on executives.
In 2010, some researchers disagreed that an executive compensation plans can stimulate an executive to overemphasize goodwill. In particular, bonus policies offer stronger incentives for overemphasizing goodwill (making little of other net assets) as compare to other types of compensation for a number of causes. As stated by Gaver & Gaver (1998) and Murphy (1999), first, bonus policies characteristically state yearly incomes as the performance measure, while other compensation’s types do not. Therefore, bonus is more probable as compare to equity-based compensation to intensify with the exaggeration of goodwill as well as earnings because of unambiguous contracting. Previous researches demonstrate that an executive bonus is often linked with earnings (Holthausen et al. 1995). Furthermore, because of the influence of an executive, revising the bonus agreement in order to modify the goodwill’s misstatement can be beyond once reach. On the contrary, equity-based compensation is associated to stock price that can completely modify the goodwill’s overstatement as well as earnings with no costly re-agreement. Larcker et al. (2007) come across that nonstandard or irregular accumulations are elevated when the compensation blend is weighted with regard to accounting-based compensation plans. After that, overemphasizing goodwill boosts the chances of impairment cancellation in the future and equity-based compensation is expected more influenced via such rejections than bonuses. According to Dechow et al. (1994) and Gaver & Gaver (1998), executive cash compensation is secured from infrequent losses. However, some researchers analyzed that goodwill impairment write-offs set off considerable unconstructive market responses (Li et al. 2009; Bens et al. 2007).
According to Murphy (1999), accounting-based performance measures except earnings are utilized in bonus policies as well. Plus, some subjective facts recommend that in contemporary times, organizations have taken up cash flow based performance evaluations in bonus policies to diminish opportunistic incentives formed by earnings based performance evaluations (Leone 2004). If an executive bonus is also coupled with cash flow based factors, the influence of amortization on an executive bonus is expected to be less and bonus agreements would give ineffectual incentives for executives to deform the portion of purchase price flanked by goodwill and other assets. Consequently, it is predicted that the positive correlation between the significance of bonus in executive compensation and the share to goodwill turns out to be weaker when cash flow is incorporated as an executive performance measure.
In view of the fact that share price appears to indicate long-run payoffs in a better way, and net income indicates short-run payoffs of existing executive activities, an adaptation of the blend of accounting-based and share-based compensation guiding principles permits for setting an executive decision perspective. Besides, in the compensation plan, the relative ratio of both measures i.e. net income-based and stock price-based payoff is also vital in order to achieve a well-organized agreement and having desired threat reduction properties for executive.
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Executive compensations disclosed by four listed banks in Australia
Commonwealth Bank of Australia
According to Jane Hemstritch (Committee Chairman), the compensation structure at Commonwealth bank of Australia is planned to fascinate and keep major executive proficiency, identify the involvement of each and every person, and stimulate their people to attain good performance paralleled to their business tactic. For the 2013 financial year, they have made a decision not to make any predetermined remuneration gains for their most leading executives. The reason beside it is to make the compensation decisions parallel with the sustainability of their business upshots. This incorporates the CEO and Group Executives, Executive General Managers and General Managers. Also, for the same year, fees remunerated to non executive directors will keep on unaffected.
According to the Commonwealth officials, earnings of Ralph Norris (chief executive of Commonwealth Bank of Australia) comprise long-term incentives that possibly will not be remunerated. 2010, these incentive payments were supported by the 20% progress of bank in earnings to a record 5.66 billion dollars. In addition, at the yearly general meeting, shareholders marked their ballot for his compensation.
Westpac
At Westpac, the compensation framework merges market competitive pay levels in order to retain and catch the attention of competent executives as well as group executives who have the talent to generate shareholder value in the business, with a solid association between executive pay and the performance of both an individual and group.
Westpac’s long-term tactical objective and overall business performance are the focal point of the directors. Executives hold a vital section of their yearly remuneration associated to achievement of goals that are planned to make an enduring sustainable shareholder value.
The Group’s compensation strategy, executive compensation structure, plans as well as procedures – all show the consistent risk management that is essential to the mode they run. The performance of each section surrounded by the Group is evaluated and considered with reference to how risk is handled and the consequences influence compensation results.
The executive compensation structure particularly incorporates elements to consider risk. The structure contains a blend of predetermined pay and adjustable reward, a section of which is delayed. Both CEO and leading Executives obtain overdue compensation in the following two modes:
- Overdue shares as component of the STI
- An LTI award of performance share privileges (give value if the Group encounters or goes beyond set performance barriers)
These assist to line up the interests of the CEO as well as leading Executives with those of shareholders. For 2012, financial gain made up 40% of the executives scoreboards.
ANZ
At ANZ, compensation structure is planned to focus their people on generating and improving value for their shareholders as well as other stakeholders. The sector aspires to make certain that there is a robust association between the long and short-term interests of both the executives and shareholders.
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National Australia Bank
According to a spokesperson for National Australia Bank (NAB), executive compensation at NAB is completely associated to the performance of the bank and incorporates the attainment of customers, workers and shareholder goals.
Cameron Clyne, chief at NAB, obtained a 12% pay increase to 8.67 million dollars (last fiscal period). The annual report of NAB presents his entire package. It includes a basic pay of 2.7 million dollars – with equity allowance value 3.8 million – and simply more than 2 million dollars in short-term cash bonuses. Clyne’s cash bonus is increased by 5%, from the preceding financial period.
3.1: Executives Performance Measures During 2007-2010
For the four banks, the following are their three chief factors of compensation:
- Fixed Remuneration,
- Short Term Incentive (STI)
- Long Term Incentive (LTI)
In 2007, CAB’s executives were evaluated by measuring real outcome of key performance indicators (KPI) adjacent to operating goals and behavioral values relating to their division of accountability. Some of the KPIs are prosperity, market share, asset growth, and costs. For the same year, its fixed compensation for executive general managers was 40%, STI and LTI was 30%. In June 2007, Norris’s variable compensation was 67% of the entire compensation. In 2007, NAB’s fixed compensation for executive general managers was 20% to 40%, STI was 25% to 50%, and LTI was 15% to 35%. For the same year, ANZ’s fixed compensation for the disclosed executive was 36%, STI was also 36%, and LTI was 28%. During 2007, Westpac set up performance based fixed pay increases. Westpac’s fixed compensation for group executives was 20% to 40%, STI was 45% to 60%, and LTI was 15% to 20%.
In 2008, CAB detached long-term incentives for all excluding the superior executives. Nevertheless, in 2009 the bank increased the percentage of senior executive’s compensation coupled with long-term incentives (CAB 2009, p. 68). The executive pay package was increased by 6% in 2008-09, since his long-term share based payments were raised.
In 2009, Westpac highlighted that its performance measurement for scheming STI upshots is based on both accounting based and non-accounting measures. During this period, the vital financial measure utilized is Economic Profit, which justified 50 percent of the executives’ scoreboards all through the year. For the 2009 financial period of NAB, the executive members assisted to encompass one-half of the entire STI overdue in shares, 25% to be constrained for a year and 25% for 2 years. In 2009, ANZ’s executives fixed pay of $1,000, 000, STI of $530, 000, and LTI was zero.
According to the clippings of Wall Street Journal survey 2010, the disclosed remunerations of highest-paid executives of Australia, nearly doubling Ralph Norris entire remuneration to $16.2 million. In 2010, Westpac’s executive, Gail Kelly, pay cut down to 10% due to a slide in the shares value. Kelly’s short-term incentive payment increased from $2.62 million to $2.83 million. During the same period, NAB’s executive, Cameron Clyne, received a pay gain to 45% as the net profit of the bank rose 63%. ANZ encompassed diverse equity settled share based compensation plans. Share options reserve and other equity reserves were included in share based plan 2010. In 2007, the level of fixed pay (yearly) for the executive was set for 3 years at 3 million dollars which was reviewed in 2010.
3.2: Four Listed Banks Performance and Executive Compensation – An Analysis
After an analysis of last fifteen years, it is observed that the shares of Commonwealth Bank have moved from $16 to $74, a clear gain of $58, whereas the shares of NAB have risen from $19 to $31, an increase of $12. In that period, $35.19 in dividends was given by CBA and NAB has given $22.29. CBA owners received an extra affluence of nearly $93 per share whereas NAB owners acquired $34 per share. In simple terms it can be stated that for CBA, the annual compound return was 13.7% whilst NAB received 7.2% which is fairly a huge difference. In addition, CBA paid its executives $98 million and chief executives of NAB received $108 million.
At ANZ, Mike Smith (counterpart of Cameron Clyne) obtained more than 10 million dollars for the former fiscal period. On the other side, Gail Kelly, the person in charge of Westpac, received an entire package of 9.86 million dollars. Besides, Ralph Norris, the chief executive of CBA, received 8.64 million dollars. Nevertheless, both Kelly as well as Smith saw their bonuses cut down. For the year, Gail Kelly of Westpac saw her short-range cash bonus decline by almost $460,000, while Mike Smith of ANZ will be given a reduction of $750,000 in cash bonuses.
3.3: Executive Compensations and the Global Financial Crisis (GFC)
The global financial crisis (GFC) in 2008 expanded over a lengthy span of time.
A latest International Monetary Fund paper disagrees that there is a U-shaped association between bank rivalry and steadiness. And that a middle level bank competition is most advantageous. Although the data is disorganized, Australia seems to have had an intermediate degree of bank competition in 2008. And its banking systems were stable in the GFC.
In March 2009, Ian MacFarlane, ex Reserve Bank of Australia director, pointed toward the four pillars banking guiding principle. The ‘four pillars’ guiding principle, which dates back to the Hawke-Keating administration in 1990, averts mergers between the four leading financial sectors of Australia namely, Commonwealth Bank, Westpac, ANZ and NAB.
Due to the worldwide recession, the financial system of Australia and also financiers faced a decline in bonuses. In the beginning of the worldwide crisis, monetary organization UBS made a confidential agreement to secure Australian financiers’ bonus. As stated by The Fiscal Times, this was primarily to evade topmost workers from being hired by opponent organizations, hence avoiding impairment to a particular market. In 2012, the UBS had dragged out this contract to 2 more years. Executives of a number of key Australian banks stated that they got an increase in pay that year. It was stated by the The Motley Fool that both Ralph Norris of the CBA as well as Cameron Clyne of NAB have acquired a pay increase to above 8 million dollars, whereas Mike Smith of the ANZ got an increase to 10 million dollars.
Conclusion
Accounting based executive compensation plans are utilized by a great proportion of organizations. In this analysis, accounting-based executive compensation plans are significantly scrutinize and the considered banks are Commonwealth Bank, Westpac, ANZ, and National Australia Bank. Fixed remuneration, short term incentive (STI), and long term incentive (LTI) are provided. The compensation structure at CAB is designed to enthrall key executive aptitude, categorize the participation of each and every person, and fuel them to get superior performance paralleled to their business policy. At Westpac, the compensation framework unites market competitive pay levels so as to preserve and magnetize competent executives as well as group executives who possess the aptitude to make shareholder value in the business, with a dependable connection flanked by executive pay and the performance of both an individual and group. At ANZ, compensation structure is intended to focus their people on generating and enhancing value for their shareholders as well as other stakeholders. The division aspires to double-check that there is a robust association between the long along with short-term interests of both the executives and shareholders. NAB’s executive compensation is totally allied to the performance of the bank and also integrates the attainment of workers as well as shareholder targets. It is concluded that in the compensation plan, the relative amount of net income-based and stock price-based payoff is imperative so as to attain a desired threat reduction properties for executives.
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