Corporate Governance

Youchaa KHODR
3rd Edition
Pearson Prentice Hall

1 Corporate Governance
 Chapter 2

Executive Incentives

2 Corporate Governance
 Introduction

 The structure and conduct of corporate

governance and the methods used in the
measurement of company operations,
accounting, principles, and practice vary
dramatically across countries
 Taxation and accounting are
fundamentally related

3 Corporate Governance
 Corporate Governance

 The relationship among stakeholders used to

determine and control strategic direction and
performance of an organization is termed
corporate governance
– The way in which order and process is established
to ensure that decisions are made and interests
are represented properly for all stakeholders

4 Corporate Governance
 The Structure of Corporate
Governance
 The internal forces, the officers of the corporation
and the Board of directors, are those directly
responsible for determining the strategic direction
and the execution of the company’s future

 The external forces include:

– The equity markets
– The analysts
– The creditors and credit agencies who lend them money
– The auditors
– The multitude of regulators
5 Corporate Governance
 Potential Managerial Temptations

 Being in a managerial position, we are

tempted to have self-serving actions, like:
1. Hiring friends
2. Consuming excessive perks
3. Building an empire
4. Taking no risk or chances to avoid being fired
5. Having a short-run horizon if near retirement

6 Corporate Governance
Executive Compensation

• CEO has substantial stock ownership

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7
Executive Compensation

• CEO has substantial stock ownership

• Salary, bonuses, & stock options reward
superior performance
 not size of the company

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Executive Compensation

• CEO has substantial stock ownership

• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance

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Executive Compensation

• CEO has substantial stock ownership

• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance
• No modification of performance goals
 No re-pricing or swapping stock options

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10
Executive Compensation

• CEO has substantial stock ownership

• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance
• No modification of performance goals
 No re-pricing or swapping stock options
• Expense stock options
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11
 Executive Compensation
Executive Compensation
Salary, Bonuses, Long term incentive compensation
- Executive decisions are complex and non-routine
- Many factors intervene making it difficult to establish
how managerial decisions are directly responsible
for outcomes
- In addition, stock ownership (long-term incentive
compensation) makes managers more susceptible to
market changes which are partially beyond their contro
Incentive systems do not guarantee that
managers make the “right” decisions, but they do
increase the likelihood that managers will do the
Corporate Governance Dr. Carlo Haoui
things for which they are rewarded
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Stock Option
• Stock Options are contracts that allow
executives to buy shares of stock at a fixed
price, called the exercise or stock price.

• If the price of the stock rises above the stikr

price, the executive will capture the
difference as a profit.

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13
Stock Option (cont.)
• Stock options give the executives of the
firm the incentive to manage the firm in
such a way that the stock prices increases.

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14
Restricted Stock
• Is a common stock that includes a limitation
that requires a certain length of time to pass
or a certain goal to be achieved before the
stock can be sold.

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15
Performance shares
• Refer to a company’s stock given to
executives only if certain performance
criteria are met

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Potential “Incentive”
Problems
• Executives cook the numbers
• Executives may try to increase stock prices
• Executives may try to manipulate earnings
and thus, maximize profits in one target
year to make the stock price more
favorable.

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Accounting Diversity
• The fact that accounting
principles differ across
countries is not, by itself, a
problem
• The primary problem is that
real economic decisions by
lenders, investors, or
government policymakers may
be distorted by the differences

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Principal Accounting Differences
Across Countries
International accounting diversity can lead
to problems in international business
conducted with the use of financial
statements
 Poor or improper decision making
 Hindering the ability to raise capital in differing
markets
 Hindering from monitoring competitive factors

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Principal Differences: The Issues
• The resulting impact of accounting differences is to
separate or segment international markets for investors
and firms alike
• Communicating the financial results of a foreign
company operating in a foreign country and foreign
currency is often a task that must be undertaken
separately from the accounting duties of the firm
• Nine major areas of significant differences in
accounting practices across countries serve to provide
understanding of this issue and highlight some of the
major philosophical differences

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 Principal Differences: The Issues
• Accounting for research and development expenses
• Accounting for fixed assets
• Inventory accounting treatment
• Capitalizing or expensing leases
• Pension plan accounting
• Accounting for income taxes
• Foreign currency translation
• Accounting for mergers and acquisitions
• Consolidation of equity securities holdings

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International Taxation
• Governments alone have the power to
tax
• Governments want to tax all companies
within their jurisdiction without
placing burdens on domestic or foreign
companies that would restrain trade
• Each country will state its
jurisdictional approach in the tax
treaties it signs with other countries
 Treaties establish the bounds of
jurisdiction to prevent double taxation

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 Tax Jurisdictions and
Tax Types
• Nations usually • Taxes are generally
follow one of two classified one of two
basic approaches to ways
international
 Direct Taxes
 Indirect Taxes
taxation
 Residential approach
• The value-added tax
(VAT) is the primary
 Territorial or source
revenue source for the
approach
European Union

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 Income Categories and
Taxation
• There are three primary
methods used for the transfer
of funds across tax
jurisdictions
 Royalties
 Interest
 Dividends

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 U.S. Taxation of
Foreign Operations
• The U.S. exercises its rights to tax U.S. residents’
income regardless of where the income is earned
• The income of a foreign branch of a U.S. corporation is
treated the same as if the income was derived from
sources within the U.S.
• Corporations operating in more than one country are
subject to double taxation
• The calculation of foreign income taxes deemed paid
and the additional U.S. taxes due involves the
interaction of four components

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 Calculations of U.S. Taxes on
Foreign-Source Earnings: Four Cases
• Foreign affiliate of a U.S. corporation in
a high-tax environment
• Foreign affiliate of a U.S. corporation in
a low-tax environment
• Foreign affiliate of a U.S. corporation in
a low-tax environment, 50 percent
payout
• Foreign subsidiary of a U.S. corporation
is a CFC in a low-tax environment
Corporate Governance 26
 Auditors and Regulators
• Auditors are responsible • Regulatory oversight of
for providing an external publicly traded firms in
professional opinion as to the U.S. is provided by
the fairness and accuracy governmental and
of corporate financial nongovernmental
statements agencies
• These individuals follow  Securities and Exchange
the generally accepted Commission (SEC)
accounting principles
 Applicable stock exchange

Corporate Governance 27