Chief executives (CEOs) with multi-million-dollar pay tickets 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 RM10 million bonuses encourages them to make short-term 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 to be 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 Malaysia encourage director independence. But this often means directors do not have a deep understanding of the business. Relying on financial performance measures means directors do not need to really understand whether CEOs are good leaders, insightful, pursuing the right strategies and communicating well.

Requirements:

A1.1. One of the problems in the shareholder/manager agency relationship that pay contracts are designed to overcome is the horizon problem. State what the problem is and explain how the contract between managers and shareholders can be designed to reduce the horizon problem.

A1.2.

The above passage highlights the excessive use of bonuses to encourage short-term decisions. From an agency perspective, why would managers prefer short-term cash bonuses instead of long-term equity bonuses? What problems does this approach lead to for the board of directors and shareholders? Why does this not align with shareholder interests? Explain your answer.

Part B

B1.1 How does good financial reporting add value to organisations?