5.2 CASE STUDY

$10M CEO BONUSES ENCOURAGE SHORTTERM DECISIONS

Chief executives with multimilliondollar pay packets are not necessarily working in the best interests of shareholders and there may be a case to cap their pay. New research explores whether limits on executive pay hurt or benefit shareholders and suggests that providing CEOs with $10 million bonuses encourages them to make shortterm decisions rather than work closely with the board and in the best interest of shareholders. The research proposes that limiting executive compensation might be more beneficial for shareholders. Over the past 30 years, CEO compensation has been increasing on the basis of a theoretical argument that it creates shareholder value. However, the current system encourages companies to be 'transactional focused' rather than building capacity and innovating; CEOs are likely to pursue strategies with outcomes that are easy to measure in financial terms. It has been proposed that the current corporate governance structure and guidelines in Australia encourage director independence. But this often means that directors do not have a deep understanding of the business. Relying on financial performance measures means directors do not need to really understandwhether CEOs are good leaders, insightful, pursuing the right strategies and communicating well. QUESTIONS

1. One of the problems in the shareholder/manager agency relationship that pay contracts are designed to overcome is the horizon problem. Outline what the problem is and how the contract between managers and shareholders can be designed to reduce the horizon problem.

2 The article highlights the excessive use of bonuses to encourage shoreterm decisions. From an agency perspective, why would managers prefer shortterm cash bonuses instead of longterm equity bonuses? What problems does this approach lead to for the board of directors and shareholders? In presenting your answer you should refer to relevant information in the above article to support your view.

3 Why would managers prefer shortterm cash over longterm equity bonuses? Why does this not align with shareholder interests? Explain your answer.

5.3 CASE STUDY

SUPPLY CHAIN USING CHILD LABOUR OR PAYING UNFAIR RATES CAN DESTROY A BRAND

Consumers are becoming increasingly budgetconscious, which has encouraged retailers to seek efficiencies through their supply chain. This has led, in many cases, to sourcing stock from manufacturers in countries that pay low pay rates. However, this can carry additional risks. Now investors are calling for greater transparency from public companies over the sourcing of clothing, footwear and textiles from Asia, warning that chasing cheaper labour to reduce costs can backfire and ultimately damage fashion brands. They are putting pressure on public companies to provide more information about their supply chain, including details of which countries goods are coming from. It is important for investors to consider which companies are managing these risks, when making investment decisions. However, public disclosure is often quite poor, leading investors to seek further information from other sources; they are seeking greater transparency and have put ethical supply chain management under the spotlight. The collapse of a garment factory in Bangladesh in April 2013 that killed more than 1000 workers increased the focus on the issue and now retailers are expected to disclose the extent to which they areexposed to one of the poorest countries in Asia and sign international labour agreements on sourcing and pay. Concerns about sources of goods have existed for years, however. Decades ago, footwear group Nike was exposed in a sweatshop scandal. That was followed by other scandals, including the discovery that footballs used in the Australian Football League were made by children. Investors who are signatories to the UN Principles for Responsible Investment identify supply chain labour standards as one of their priority areas for engaging with companies. Source: Adapted from Eli Greenblat, 'Pressure on retailers to act ethically', The Age.

QUESTIONS

1 The above article discusses investors' call for more transparency in regard to human rights and employment issues through companies' supply chains. Many companies discuss this information in their sustainability report. What is sustainability? Provide three examples of activities that are considered to have an impact on the sustainability performance of a company.

2 Corporate decisions to voluntarily disclose information about policies and practices relating to human rights and employment can be explained using a number of theories addressed in this unit. Discuss one of these theories, and explain, from a theoretical viewpoint, why firms would choose to provide this information when they are not formally required to do so.

3 How does a company's supply chain relate to determining sustainability of an organisation's operations? Explain your answer, supporting your view with examples from the article.