Contemporary Issue in Accounting 2014
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! This+assignment+may+be+completed+in+groups+of+up+to+3+students.++Groups+are+not+ compulsory+and+students+are+welcome+to+make+individual+submissions+
Topic:+ Positive+accounting+theory+–+contracting+theory+
! Background! Contracting!theory!characterises!the!firm!as!a!legal!nexus!of!contractual!relationships! organizing!economic!activity!to!reduce!contracting!costs.!!An!agency!relationship!arises!from! a!contract!where!one!party!(the!principal)!engages!another!party!(the!agent)!on!their!behalf.!! One!of!the!most!significant!agency!relationships!is!that!between!managers!and! shareholders,!whereby!the!separation!of!ownership!and!control!means!that!managers,!as! agents!of!shareholders,!can!act!in!their!own!interests!–!many!of!which!may!not!be!in!the! interests!of!the!shareholders.!
There!are!a!number!of!problems!that!can!cause!differences!in!shareholders’!and!managers’! incentives!regarding!company!policies,!including!the!risk!aversion!problem!and!the!horizon! problem.!
The!task!
The!accounting!firm!for!which!you!work!has!a!number!of!clients!who!are!interested!in!salary! packaging!options!for!their!senior!executives.!!A!major!component!under!consideration!is! bonuses!–!shortRterm!cash!bonuses!and!longerRterm!equity!bonuses.!
You!are!required!to!compile!a!report!for!management!of!your!accounting!firm,!which! addresses!the!issues!outlined!below.!!The!report!must!offer!practical!information,!but!also! outline!the!theoretical!perspectives!mentioned!in!the!specific!questions.!!You!are!not! required!to!provide!any!recommendations!in!relation!to!salary!packaging,!as!your!report!will! be!used!by!management!to!provide!betterRinformed!advice!to!clients.!
The!article!below!provides!some!useful!discussion!in!relation!to!this!issue!–!although!it!was!
published!in!2007!it!is!no!less!relevant!today.!
! The!issues!that!your!report!must!address!are:!
1.!One!of!the!problems!in!the!shareholder/manager!agency!relationship!that!pay!contracts! are!designed!to!overcome!is!the!risk!aversion!problem.!Outline!what!the!problem!is,!and! how!the!contract!between!managers!and!shareholders!can!be!designed!to!reduce!risk! aversion.!
2.!How!does!equity!as!a!pay!component!work!to!reduce!the!horizon!problem?!What!role,!if! any,!does!accounting!information!play!in!specifying!the!contractual!terms!of!bonus!plans! designed!to!reduce!the!horizon!problem?!
3.!The!article!discusses!a!range!of!nonRsalary!components!that!are!contained!within!the!
management!compensation!packages!of!topR100!companies.!What!is!the!purpose!of!
including!nonRsalary!components!in!executive!pay!arrangements?!
4.!Why!would!managers!prefer!shortRterm!cash!over!longRterm!equity!bonuses?!Why!does!
this!not!align!with!shareholder!interests?!!
5.!Shareholders!of!Australian!entities!have!the!ability!to!vote!to!show!either!their!support!or! dissatisfaction!with!companies’!remuneration!reports.!While!this!is!nonR!binding!on!the! Board,!they!are!obliged!to!take!note!of!shareholders’!views.!Explain!why!shareholders!might! choose!to!vote!against!reports!with!too!high!a!proportion!of!pay!as!shortRterm!cash!bonuses! rather!than!longRterm!incentives.!
Pay+backlash+prompts+shift+to+bonuses+
By!Patrick!Durkin!
Boards!of!topR100!companies!are!paying!their!chief!executives!larger!annual!cash!bonuses!to! avoid!an!embarrassing!investor!backlash!over!pay,!experts!say.!
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