DEVELOPMENT OF THE MODERN CORPORATION

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DISCLOSURE OF EXECUTIVE REMUNERATION

The general un-observability of executive actions often leads to information asymmetry in relation to corporate information.  Holström (1979) suggests that a natural remedy to this problem is to invest resources into the monitoring of executive actions, which causes agency costs.  Healy and Palepu (2000) aver that this information asymmetry and agency conflicts between managers and shareholders create a need and demand for disclosure.  They however suggest that, in view of the virtual non-existence of empirical research on the regulation of disclosure, that it is necessary to consider whether disclosure presents investors with new and timely information, and if so, what the cost-benefit results thereof would be.  Blair and Ramsay (1992) add that it is not in the interest of investors to disclose information if the cost outweighs the value there of.Disclosure therefore always presents choices between costs and benefits for both the organisation and its stakeholders. As with most other aspects of corporate governance and executive remuneration, it is often required to apply art rather than science to resolve these choices.The most fundamental requirement for reporting on executive remuneration is transparency. The concept of transparency has however not been universally accepted, and the extent of transparency to an even lesser degree. In many countries disclosure and transparency of remuneration is still against the prevailing culture, while in others a clear distinction is made between transparency and illumination (ICGN, 2002). There is consequently little consistency around the world regarding disclosure practices. Although there has been a global trend towards more disclosure of executive remuneration policies and levels in recent years, it has been at the expense of clarity and simplicity. The complexity that often characterises modern disclosures has led to a general lack of proper analysis and monitoring by investors and analysts alike. This lack of clarity and simplicity in disclosure of executive remuneration often leads to investor and stakeholder distrust of companies, and as has been disclosed in the McKinsey report (2002) to consequent unwillingness of investors to invest in companies where they have lacking information in. Most corporate governance codes advocate that transparency is the basis on which trust between the company and its stakeholders is built.Ferrarini, et al. (2003) propose that there are two prominent issues in the disclosure debate, namely whether disclosure remedies or aggravates executive remuneration problems, and whether disclosure amounts to additional agency costs. Although both of these issues are directly relevant in the executive remuneration debate, it is fair to question whether it presents a numerous clauses of issues to be considered. Ablen (2003) goes further to suggest that disclosure of executive remuneration policy and levels is significant in that it articulates the pay-setting process, and allows for executives to be held accountable for their actions. The author adds that disclosure has both intended and unintended consequences. The intended consequences of disclosure consist of the informative value and regulatory technique thereof, while the unintended consequences relate to privacy deprivation and ratcheting pay benchmarking practises. Ablen concludes that informed and active shareholder oversight, enabled by sufficient disclosure, is required to balance these consequences. Although the principle of disclosure as a corporate governance control measure is sound, differences between environments of companies would conceivably require differences in the form and extent of their disclosures.This chapter analyses the underlying reasons why companies may need or choose to make disclosures, as well as the factors which influence differences in the form and extent of these disclosures. It also investigates modern trends in disclosure practices.

The reasons for disclosure

Aboody and Kasznik (2000) hypothesize that corporate information asymmetry leads to executives opportunistically manipulating the timing of information disclosures to advance their own interests.  In particular, executives have the power and opportunity to delay publication of good news and rush publication of bad news to gain maximum benefits for themselves.  Such a strategy results in a decrease in stock value before awards to executives and a rise of value after the executive awards, and consequently in financial gains to the executives.Becht, et al. (2005) consider such a practice as self-dealing.The need for mandatory disclosure has been the subject of considerable theoretical debate.  Some commentators have questioned the value of mandatory disclosure rules by suggesting that unfettered market forces will produce optimal disclosure.  Others argue that disclosure is necessary to overcome market failure (Blair and Ramsay, 1992).  The authors list the arguments for and against voluntary disclosure as appear in Table 2 below.

The nature and extent of disclosure

Conyon, et al. (1995) aver that the current extent of corporate disclosures is woefully inadequate.  Disclosure of relevant information is often discretionary.  The lack of disclosure consistency does not always facilitate adequate comparisons within even the same industry.Ideally, disclosure of executive remuneration should enable investors and analysts to understand the nature, expected outcomes, costs and benefits of remuneration policies, and the link between executive remuneration and performance (ICGN, 2002). There is however currently significant inconsistency amongst countries in respect of their disclosure regimes and requirements, which do not always allow for informed stakeholder decisions. Often the devil is in the detail insofar as disclosure is concerned with making sufficient information available to enable shareholder decisions. Ablen (2003) state that shareholders have a legitimate interest in the disclosure of all elements of executive remuneration, as it controls agency conflicts by allowing shareholders to gage the level of divergence between shareholder and executive interests, and the link between remuneration and performance. Successful disclosure therefore rests on its ability to convey meaningful information that is useful to stakeholders to protect their interests.The form of disclosure is as important as the content thereof. It should be simple, clear and standardised to make it comprehensible. Hill (2006) however suggests that self-serving executives would often disclose executive remuneration in exceedingly complex manners to camouflage any traces of selfservice. Contentious aspects of executive remuneration are for example often disclosed in the chairman’s reports in the annual reports of companies, in order to escape shareholder votes thereon. This is indicative of the inherently conflicted arena within which executive remuneration is determined and disclosed, and the significant positional power enjoyed by executives, who are often resistant to full disclosure. A system of mandatory disclosure should ensure that all stakeholders have equal access to information, and should present simplified and standardised information that is easily understood (Blair and Ramsay, 1992).  This statement is however based on two assumptions that have been criticized before, namely that ill-informed investors need protection, and that additional disclosure is the appropriate form of protection.Hill (2006) further contends that developments in executive remuneration practice, some of which are directly attributable to the attempts of executives to hide their self-service in complex systems, have outpaced the required developments of traditional legal and governance frameworks, which should be developed to deal adequately with modern remuneration practice credible. Such a development is without a doubt, necessary in view of the statements in, amongst others, the Greenburg Committee Report in the UK, and the King II Report in South Africa, that disclosure of executive remuneration is the key means to promote corporate accountability and legitimacy. The disclosure requirements under the SEC rules in the USA is viewed by Hill (2006) as the international best practice benchmark. These rules require, amongst others, that the board, through a remuneration committee, should report annually to shareholders on the company’s remuneration policy, individualised executive remuneration levels, and all components of executive remuneration packages, in standardised tables and graphs. The underlying principle is that disclosure is not meaningful per se unless it is presented in a clear, comprehensible and comparative form, and in a meaningful context which enhances managerial accountability. The approach in terms of the SEC rules is however strongly prescriptive in terms of specific governance control measures which may not be practical universally. A principled approach, supplemented by a flexible set of best practice guidelines, as preferred in the King III Code in South Africa, is more suited to be applied across diverse organisations and industries.Donham (1922) already suggested that there are vast learning opportunities in the disclosure of information. According to the author, information is king, but only to the extent that it is sufficient to lead to meaningful action. Epstein and Roy (2005) state that disclosed information should enable boards to determine whether executive remuneration strategy meets its objectives, and figures alone will not achieve this. The popular practice of companies to disclose only remuneration levels instead of the factors which have informed those levels is therefore highly questionable. In some European countries it is still a prevailing culture to disclose the minimal required information. Ferrarini, et al. (2003) ascribe this to entrenched cultures of non-disclosure, and corporate ownership structures characterised by block holding, but suggest that there are some indications that European companies are converging towards fuller disclosure similar to levels in Anglo-American systems. The comprehensive disclosure requirements contained in the UK Combined Code is indicative of this shift.Ferrarini and Moloney (2005), after studying the disclosure regimes across a number of EU countries, conclude that there are two distinct groups in respect of disclosure systems. On the one hand there are countries such as UK, France, Ireland, Italy, the Netherlands and Sweden which require maximum transparency, detailed and individualised remuneration disclosures, full disclosure of remuneration policy, and a remuneration governance system based on the “comply or explain” principle. On the other hand the remainder of EU countries such as Germany, Austria, Spain, Belgium, Luxembourg, Denmark, Finland, Greece, Portugal, where companies are generally characterised by block holding ownership, require minimal, aggregate disclosure of total executive remuneration, which is attributable to prevailing privacy and cultural preferences. The predominance of aggregated disclosure across the EU, combined with inconsistent disclosure practices, makes accurate direct remuneration comparison, and determination of pay trends very difficult. The authors however observe that less sophisticated disclosure practices were directly linked to governance failures. They therefore conclude that full disclosure is the link between executive remuneration design flaws and effective corporate governance, as well as between pay and performance.These two different disclosure systems seem to be representative of a similar distinction across the world. Finsch (2006) refers to the relatively new mandatory full disclosure system in Australia, which requires annual disclosure of both executive remuneration policy and individualised levels of remuneration linked to performance criteria, by all listed companies. The author concludes, after a study of Australian firms listed on the ASX in 2006 that there is a high degree of uniformity of disclosure amongst Australian firms, and a much higher quality of disclosure amongst those firms with a higher market capitalisation. In New Zealand however, Sheffield (2007) found that the minimal disclosure requirements in the country were not aligned with international best practise, which potentially impacted on New Zealand companies to remain competitive in the market for executive talent.Shim (2006), in accepting that full disclosure has both advantages and disadvantages, proposes a hybrid model for disclosure, in terms of which voluntary codes would be supplemented by formal legislative regulation if companies do not disclose adequately in accordance with its own circumstances. The legislative imposition of maximum caps to executive remuneration in the USA in 2009, following federal support to companies struggling to survive the global economic meltdown of the time, is a prime example of how public opinion influences legislative interventions. Self serving executives have become the frog in the pond, and society is cooking the water by means of increased legislation and regulation.The question could however be asked whether legislation is a practical a tool to supplement a voluntary code, or whether the opposite is the case. In most instances, legislation sets out the minimum formal requirements (“letter of the law”) while codes set out practical guidelines to give effect to such legislation (“spirit of the law”). Although it is inevitable for legislation to be imposed where codes and self regulation fail to encourage required actions from executives, it seems unlikely that formal legislation would ever serve to support voluntary codes as a form of governance regulation.Irrespective of which disclosure regime is in operation in a country, disclosure is often flawed because it is either incomplete, piecemeal or unclear in its reach. Hill (2006) argues that any  disclosure regime that does not fully disclose a company’s remuneration policy and individualised executive remuneration packages, to which information shareholders have a legitimate right, is fundamentally flawed in that it leads to inequities in respect of access to information, and consequently to agency problems. Adequate disclosure could serve a vital role in addressing these flaws. Meek, et al. (1995) composed a voluntary disclosure checklist, copied as Annexure D hereto, which contains 85 items in 12 sub-groups of 3 groups.  This list is a most helpful tool towards the design of an effective disclosure system for a company. These items should however only serve as a guide from which companies design disclosures that are appropriate for their individual needs.

1. INTRODUCTION
1.1 Problem statement
1.2 Research objectives
1.3 Contribution of the research to existing body of knowledge
1.4 Limitations of the research
1.5 Definitions of key terms
1.6 Assumptions
1.7 Chapter Plan
2. LITERATURE REVIEW
3. DEVELOPMENT OF THE MODERN CORPORATION
4. CORPORATE GOVERNANCE
4.1 Background and development of corporate governance in modern business
4.2 Forms of corporate governance measures
4.3 Corporate governance regulations
4.4 Problems associated with corporate governance
4.5 Corporate governance trends
4.6 Concluding remarks
5. EXECUTIVE REMUNERATION
5.1 Origins and nature of executive remuneration
5.2 Composition of executive remuneration packages
5.3 Executive remuneration theories
5.4 Problems associated with executive remuneration
5.5 Modern trends in executive remuneration
5.6 Conclusion
6. DISCLOSURE OF EXECUTIVE REMUNERATION
6.1 The reasons for disclosure
6.2 The nature and extent of disclosure
6.3 Disclosure trends
6.4 Conclusion
7. THE ROLE OF DISCLOSURE OF EXECUTIVE REMUNERATION IN A CORPORATE GOVERNANCE FRAMEWORK
7.1 Executive remuneration and corporate governance
7.2 Disclosure and corporate governance
7.3 Conclusion
8. CONCLUSIONS FROM LITERATURE REVIEW
9. RESEARCH PROPOSITIONS
9.1 First Proposition
9.2 Second Proposition
9.3 Third Proposition
9.4 Fourth Proposition
10. METHODOLOGY
10.1 Research methodology and design
10.2 Sample selection
10.3 Data collection and preparation methods
10.4 Justification for using these methods
10.5 Research instruments
10.6 Method for testing propositions
10.7 Nature and form of results
11. ANALYSIS AND RESEARCH RESULTS
11.1 Disclosure requirements
11.2 Sample selection and quantitative analysis
11.3 Qualitative analysis
12. CONCLUSIONS AND RECOMMENDATIONS
12.1 Research problem
12.2 Research objectives
12.3 Research propositions
12.4 Research analysis and results
12.5 Findings on research propositions
12.6 Recommendations
12.7 Future research
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DISCLOSURE OF EXECUTIVE REMUNERATION AS A CORPORATE GOVERNANCE CONTROL MEASURE IN SOUTH AFRICAN LISTED COMPANIES