4.You have recently been appointed as a lending officer in the commercial division of a major bank. The bank is concerned about lending in the current economic environment, where there has been an economic downturn. You have been asked by your supervisor to provide a report indicating how you can safeguard the bank against the risks of lending.
1.Managerial pay and performance are balanced by the organization with the help pay for performance system. It is done through the concept of performance appraisal. The organization draws a line of difference and projects them that help them to have a strong focus on the goals. The organization designs a number of methods that are in tune with the functioning of the company (Parrino et. al, 2012). Further, the organization must consider that the performance goals and measure are relevant, reasonable and usable because it helps the employees to understand and take active participation in the performance evaluation process. The organization should have a pay for performance system and must devote appropriate time to the evaluation of the performance (Marsh, 2009). The organizations ensure proper balance with the aid of strong policies that consider the performance and the payment measures. It just needs to ensure that the benefits of either party are not suppressed as it might create differences.
2.BHP Billiton listed on the ASX and a pioneer in the mining sector is considered for the purpose of a study. Mr, Mackenzie is the CEO and the total remuneration for FY 2017 stands at USD4.554 million as compared to a figure of USD 2.241 million in the year 2016. The main difference for the figure appears in the fact that he did not receive any STI for the year 2016 because of the dam failure together with a fall in the commodity market that affected the performance. Moreover, the LTI in 2016 stands at zero and the same was repeated in 2017.
The base salary of Mackenzie stands at USD 1.700 million yearly and the contribution of pension is 25 percent of base salary (BHP Billiton, 2017). There is no change to base salary or pension contribution in the year 2018.
The annual STI of the CEO is bent on incentivizing controllable yearly performance and is 160 percent of the base salary that is linked to attainment of performance. Further, a maximum of 240 percent of base salary is realizable in the scenario of major outer performance and a minimum outcome tends to be zero (BHP Billiton, 2017).
The Remuneration committee establishes the remuneration of the CEO that is based on the remuneration policy and charter. The committee considers the market condition that is prevailing, the competitive environment and the positioning of the pay scenario across the workforce of BHP. The committee ascertains the annual base salary for the employee while determining the base salary of the CEO (BHP Billiton, 2017).
The CEO can ensure with his decision-making process that the business benefits in the performance. If the business derives ample benefits from the decision-making process then the CEO can have an added advantage thereby leading to a maximum bonus.
The principal-agent model is the main model that underpins the reason why managers are compensation with stocks, options, etc. The principal-agent model stress upon the economic interaction of the uninformed party that delegates task to the informed party who private action can impact both the parties. Principal-agent model is tools that highlight the maximum incentive method that addresses the interest between principal and agent based on the preferences and information structure.
4.The separation of ownership and control implies that the managers can act as per their own interest that may be different to the shareholder interest. This can be attributed to the number of difficulties such as:
Risk aversion problem – Less risk is being preferred by the manager because human capital is linked to the firm. The main preference is to diversify the risk instead of maximizing the firm’s value.
Retention of dividend – It is a common parlance that the manager prefers to pay less out of the earnings of the firm so that they can pay their own perquisites (Bedard et. al, 2014).
Horizon problem – Managers are interested in cash flow as it influences the remuneration for the period while the shareholders have a long-term interest because share price equals the PV of the expectation of the shareholders of all future cash flow.
Bonus scheme can lessen such problem by associating the manager’s remuneration to the index of the performance of the firm that contains a high correlation with the firm’s value such as share price or earnings. This connects the managers and the interest of the shareholder by linking managerial compensation to the performance ex-ante without requiring the need to stress on the ex-post method like renegotiating the salary (Petty et. al, 2012).
4.One of the major tools for facing the moral hazard in a contract of a dent is enforcing the restrictive covenant. It is a means of reducing the moral hazard. It is done by ruling out undesirable behavior or enforcing the desirable behavior (Mock, 2010). The covenant lowers the moral hazard by stopping the borrower from going opposite to the covenant terms. Hence, this deters the borrower from grasping any investments of risky nature. On the contrary, the restrictive covenant can be utilized to influence desirable behavior (Melville, 2013). It allows the borrower to take various investments that will yield desirable results. Hence, it ensures that the loan will be repaid.
The banking industry has specified the number of agency problems. One of the prominent problems is that of limitation on the managerial wealth force that is a separation between the ownership and control. As a result of this, managers pursue the objectives at the shareholder expense. Asset risk can be defined more in banks (Bedard et. al, 2014). Accounting information can ensure strong information that helps in ascertaining the facts and figure. In the presence, if proper information, the banks will be able to take proper decision. Hence, it will aid in the smooth decision-making process. Therefore, the major help that accounting information can ensure is that of the projecting valid and meaningful information that assists in decision making. In the absence of such information, it will be difficult to operate and provide valid judgments.
Bedard, J., N., Gonthier, Besacier, & Schatt, A. (2014) Costs and Benefits of Reporting Key, Harvard Press
BHP Billiton. (2017). BHP 2017 Annual report and accounts [online]. Available from: https://www.bhp.com/media-and-insights/reports-and-presentations [Accessed 30 May 2018]
Marsh, C. (2009) Mastering financial management. Harlow: Financial Times Prentice Hall.
Melville, A. (2013) International Financial Reporting – A Practical Guide. 4th edition. Pearson, Education Limited, UK
Mock, T. (2010) A Ten-Country Comparative Analysis, Human Resource Management. [online]. 41(1), pp. 45-66.
Nau S. (2010) Adopting Fairer Compensation, American City & County. [online]. 114(1), pp. 10-21
Parrino, R, Kidwell, D. & Bates, T. (2012) Fundamentals of corporate finance. Hoboken,
Petty, J. W, Titman, S., Keown, A. J., Martin, J. D., Burrow, M. and Nguyen, H. (2012) Financial Management: Principles and Applications, 6th ed. Australia: Pearson Education Australia.