The directors of Megatron have decided to revise the executive pay structure to make it more performance-related. They have formed a new remuneration committee, which is to be chaired by Lord Footler, who is also chairman of Boxers Bank plc. Three other non-executive directors would be appointed, chosen by Lord Footler and Megatron CEO Sir ‘Billy’ Bustler. The performance measure used was to be based on the share price and the financial director was instructed to ensure that performance targets and profit forecasts were met and that there was no financial ‘bad news’ that might shake the confidence of investors. Sir Billy told him privately to transfer funds from the subsidiary companies based in low-disclosure tax havens to prop up profits if necessary. The share price was to be measured against a moving average share price of a ‘bundle’ of shares in companies which comprised a ‘typical portfolio’. These shares were carefully selected by Lord Footler and Billy Bustler. Most of the companies included in this share bundle were safe but unspectacular companies in declining industries or markets which were mature and in which no real growth was expected. Megatron’s share price was confidently expected to outperform these by some distance. In addition, all the executive directors were appointed through nominees as directors of two companies based in the Cayman Islands. They were to be paid fees and commissions by these companies but the Cayman Islands disclosure rules meant that the payments would go unrecorded in any financial statements as they were ostensibly paid to other parties. Discuss How would the principle that directors’ pay should be linked to performance actually affect the performance of the company in the short term and over the longer term? Explain the principles of agency theory and discuss the ethics of directors being able to decide their own remuneration, albeit through a remuneration committee. What mechanisms exist for dissatisfied shareholders to prevent what they see as excessive rewards to directors?
Case Study
The directors of Megatron have decided to revise the executive pay structure to make it more performance-related. They have formed a new remuneration committee, which is to be chaired by Lord Footler, who is also chairman of Boxers Bank plc. Three other non-executive directors would be appointed, chosen by Lord Footler and Megatron CEO Sir ‘Billy’ Bustler. The performance measure used was to be based on the share price and the financial director was instructed to ensure that performance targets and profit
The share price was to be measured against a moving average share price of a ‘bundle’ of shares in companies which comprised a ‘typical portfolio’. These shares were carefully selected by Lord Footler and Billy Bustler. Most of the companies included in this share bundle were safe but unspectacular companies in declining industries or markets which were mature and in which no real growth was expected. Megatron’s share price was confidently expected to outperform these by some distance.
In addition, all the executive directors were appointed through nominees as directors of two companies based in the Cayman Islands. They were to be paid fees and commissions by these companies but the Cayman Islands disclosure rules meant that the payments would go unrecorded in any financial statements as they were ostensibly paid to other parties.
Discuss
- How would the principle that directors’ pay should be linked to performance actually affect the performance of the company in the short term and over the longer term?
- Explain the principles of agency theory and discuss the ethics of directors being able to decide their own remuneration, albeit through a remuneration committee.
- What mechanisms exist for dissatisfied shareholders to prevent what they see as excessive rewards to directors?
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