1. EXECUTIVE COMPENSATION Sven-Olof Yrjö Collin

2. Me: Sven-Olof Yrjö Collin - Professor in Business Administration with emphasis on Corporate Governance and Accounting - Teach in corporate governance, accounting, management control, corporate finance, strategy, scientific method and supervise on all levels. - Research in corporate governance, for example riding schools, municipal corporations, family firms, but also executive compensation, accounting choice and auditing, duty. E-mail: sven.olof.collin@lnu.sesven.olof.collin@lnu.se Homepage: www.svencollin.sewww.svencollin.se

3. AIM OF LECTURE TO PRESENT EXECUTIVE COMPENASTION - AS RELEVANT AS POSSIBLE, i.e., AS AN HUNGARIAN SOUP AND THEN PRESENT - ONE ACCOUNTING THEORY VERSION, i.e., THE SIMPLE WATER SOUP BY POSITIVE ACCOUNTING THEORY

4. THE COMPENSATION PUZZLE Size of the firm Performance of the firm Executive Pay 40% 5%

5. 5 - 40 IN THE PRINCIPAL - AGENT CONFLICT? Size: Goal of managers AGENT PRINCIPAL Profit: Goal of shareholders

6. INSTITUTIONAL DIFFERENCES OWNERSHIP STHRENGT EXECUTIVE COMPENSATION € US, UK Germany Sweden Japan lowhigh TENDENCY TO USE OPTION SCHEMEShighlow

7. Situation AGENCY R I S K PRINCIPAL’S OBSERVATION CompetenceBehaviourPerformance PRINCIPAL - AGENT RELATIONSHIP

8. SEPARATING THE PROCESS OF COMPENSATION Mechanism of compensation Criteria for compensation Consequence

9. WHO TO COMPENSATE Individual Figure head Individual ‘unfair’ Group Collaboration Mutual Monitoring ‘back stabbing

10. MECHANISM OF COMPENSATION - Contract - Monitoring Objectivity Predictability Precision Transparency Risk Fairness

11. CRITERIA FOR COMPENSATION Performance Behaviour Individual characteristics Labour market price Position Peer comparison

12. PERFORMANCE MARKET MEASUREMENTS ACCOUNTING MEASUREMENTS SUBJECTIVE MEASUREMENTS Noise Influence Informational Motivational - Goal! - Strategy etc.

13. STRATEGY Strategy Structure Market dominancePerformance criteria: Sales growth

14. CEO DISCRETION INFLUENCING PAY Task programmability Uncertainty CEO DiscretionCompensation

15. WHEN PAY - PERFORMANCE? uncertainty CEO influence

16. BEHAVIOUR CRITERIA Actions performed by the agent subjective costly time evaluators competence

17. INDIVIDUAL CHARACTERISTICS EDUCATION COMPETENCE NETWORK

18. LABOUR MARKET supply demand Price = Wage Upper bound Consultants? Reservation wage Bidding-up hypothesis

19. POSITION COMPENSATION Figure head (Tournament theory) Social recognition Hierarchical level - responsibility - higher pay on next level Information-processing requirements

20. PEER COMPARISON REFERENCE POINT Peers Significant others

21. WHO DECIDES ABOUT COMPENSATION? The Board The Chairman of the Board The Dominant Owner The Remuneration Committee - consultants...

22. RELATIONAL CONTRACT Exchange create externality Experience => mutual expectations No time horizon => trust Tenure => No correlation Pay & Performance Tenure => Less explicit control

23. SOCIETY INFLUENCING COMPENSATION Media Social groups Ideology...more market-dependent decision makers, more fashionable compensation package

24. KAUSALITY? DECIDE ABOUT COMPENSATION IN ORDER TO - ATTRACT AN INDIVIDUAL TO BECOME A CEO (recruitment) -MOTIVATE AN INDIVIUDAL TO PROPER PERFORMANCE (incentive) -ATTRACT INVESTORS TO THE SHARE (client effect, i.e., legitimation)

25. CONSEQUENCE Base pay Variable pay Employment Prospects through reputation Intrinsic rewards

26. ALIGNING COMPENSATION Environment Organisation Strategy Individual

27. WHAT IS RISK? Return variance: Risk averse (Financial economics) Probability of loss: Loss averse (Behavioural finance) Expected value Bonus today or options for tomorrow

28. EMPLOYMENT CONSEQUENCES Downward risk: unemployment Upward risk: Promotion

29. REPUTATION - WAGE age Value of reputation

30. INTRINSIC REWARDS Job satisfaction Prospects of development Responsibility Power Good cause Nice atmosphere at the job Fun

31. EXECUTIVE COMPENSATION IN ACCOUNTING THEORY From an spicy Hungarian soup to a simple soup of water (i.e., markets) containg two ingredients, shareholders and managers, and their risk attitudes and endless needs of profit. The strength of simplicity, i.e., abstraction, The weakness of empirical insignificance and practical irrelevance

32. POSITIVE ACCOUNTING THEORY “…the only accounting theory that will provide a set of predictions that are consistent with observed phenomena is one based on self-interest” (Watts & Zimmerman, 1979:300).

33. ECONOMIC CONSEQUENCES ACCOUNTING POLICY CHOICE, LACKING DIRECT CASH FLOW INFLUENCE, CAN INFLUENCE THE VALUE OF THE FIRM BECAUSE - INEFFICIENT CAPITAL MARKET - INDIRECT WEALTH EFFECTS - FOR MANAGEMENT - FOR THE FIRM - FOR INVESTORS - FOR DEBT HOLDERS - FOR SOCIETY, -I.E. MOST STAKE HOLDERS

34. SHIRKING MANAGERS MANAGERS WITH THEIR OWN GOALS, … SO WHAT? MONITORING IS COSTLY - DIVISION OF LABOUR THROUGH SEPARATION OF OWNERSHIP AND CONTROL COMPETENCE TO MONITOR: INFORMATION – THEORY (EXPERIENCE)  TO MANAGE THE MANAGER One mechanisms is executive compensation

35. ESSENCE OF EXECUTIVE COMPENSATION FOR POSITIVE ACCOUNTING THEORY RISK SHARING INCENTIVE FOR SHAREHOLDER GOAL ATTAINMENT AND CONGRUENCE Not fairness, intrinsic rewards, employment etc

36. PAT PREDICTION I: THE BONUS HYPOTHESIS MANAGERS WITH BONUS WILL CHOOSE ACCOUNTING PROCEDURES THAT SHIFT REPORTED EARNINGS FROM FUTURE TO CURRENT PERIOD

37. PAT PREDICTION II: THE DEBT/EQUITY HYPOTHESIS MANAGERS IN FIRMS WITH HIGH DEBT/EQUITY (I.E., LOW SOLIDITY) WILL CHOOSE ACCOUNTING PROCEDURES THAT SHIFT REPORTED EARNINGS FROM FUTURE TO CURRENT PERIOD HIGH FINANCIAL RISK IS A TREATH TO MANAGERS AUTONOMY IF THE FIRM HAS CONSTRAINTS ON DEBT LEVELS

38. PAT PREDICTION III: THE SIZE HYPOTHESIS THE LARGER THE FIRM, THE STRONGER INCENTIVE THE MANAGER HAVE TO DEFER REPORTED EARNINGS FROM CURRENT TO FUTURE PERIODS Large firms have higher political costs, media attention, union attention and so on, that stimulate wage increase, tax changes, more charity and so on.