Managerial compensation systems and corporate governance in mining companies

Corporate Governance and Social Responsibility

Adoption of Corporate Governance Principles

Evaluations & Recommendations

Adoption of Corporate Social Responsibility Initiatives

In the United States, corporate governance legislation was initiated mainly directed at listed enterprises requiring executives to confirm financial statements as accurate and requiring increased oversight of boards and auditors. Private unlisted enterprise though, remains free from such regulatory control and protection.

Adoption of Corporate Governance Principles

Evaluations & Recommendations

I would recommend the following Corporate Governance principles; gleaned from the Sarbanes-Oxley Act (2002), OECD (2004), Combined Code (2003) and the Australian Securities Exchange (2007).

Corporate Governance and Managerial Compensation

Being a mining company in today's economic climate, a major responsibility as far as corporate governance goes is for the board of directors is to determine managerial compensation systems. How should managers be compensated? Should pay be tied to performance?

From an accounting perspective, organizing the firm into cost centers and evaluating managers on the basis of costs alone is essentially an input-based monitoring system. For managers, though, output measures are more likely to be used than input measures. These measures are not direct measures of effort but, instead, are what are called instrumental measures. They either measure something that is thought to be closely related to effort or compare outputs to inputs. Historically, such measures have included net income, profit margins, return on assets and return on equity (both measures that compare outputs to inputs), and growth in earnings and sales (Levitt, 2005; pg. 145). In terms of maximizing the wealth of the existing owners of the company, the company's stock price is also assumed to be related to these measures. So, increasingly, more and more companies are using the stock price itself or some compensation scheme that ties rewards to the stock price to finesse the ever-present problem of measuring effort. Still, the problem of separating the contributions management makes to performance from factors that are not under management control (luck, noise) remains (Carroll, 2001; pg. 27). How do we get out of this box?

Measures of relative performance may be one answer. Owners can measure managerial performance relative to the performance of other firms in the industry or some other benchmark. For example, managerial performance can be benchmarked against such industry wide financial ratios as profit margins, return on assets, return on shareholders' equity, and rates of growth in sales and net income. As we will discover, many companies do use such relative performance measures and measure performance against peer groups' With respect to the stock price, managerial performance can be evaluated by adjusting the change in the company's stock price for what happened to the market in general-all companies-during the same period. Suppose the 'per share' price of XYZ Corporation fell by 8% over the year. Was the decline in the share price due to poor management or to factors beyond the control of management, such as an economy wide recession? Some insights into this question can be gained by looking at what happened to a broad-based market index such as the Standard & Poor's 500. If the index fell by 20%, perhaps the managers of XYZ Corporation should be paid a substantial bonus because they were able to guide the company through the recession far better than the managers of other companies. However, if the index rose by 20% during the period, a different story emerges.

Common Pay and Performance Schemes

In the United States, senior managers' pay typically has three components: a fixed or base salary, a short-term or annual bonus payment, and a long-term bonus or performance payment. Both the short-term and long-term bonus payments are tied to performance measures, with the long-term bonus often taking the form of stock options. In 1996, the median CEO pay, inclusive of all forms of compensation, was $3.2 million in mining and manufacturing, $4.6 million in financial services, and, $1.5 million in utilities' (Lunnie, 2007; pg. 189). For U.S. CEOs, the fixed base cash salary represents between 20 and 40% of total compensation, with the fixed salary percentage being lowest among large manufacturing firms and financial services companies (a category that includes investment banks) and highest among utilities. Furthermore, the CEO's base salary as a percentage of total compensation has been dropping since 1990. However, one explanation for the reduction in fixed salaries as a percentage of compensation may be a 1993 change in the U.S. tax code that prohibited firms from deducting as business expenses nonperformance pay over $1 million to executives. Consequently, any compensation in excess of $1 million is likely to be disguised in one form or another as incentive-based pay (Carroll, 2001; pg. 121).

Corporate Governance Dividend Issues

Managers can do two things with present year's earnings: They can hand them out as cash dividends, or they can keep them in the company. If the salary is retained, management can use them to make extra investments or to pay down debt. The choice to pay down debt is part of the financing decision and is associated to the notion of an optimal capital structure and solving governance troubles through the financial structure decision. So, setting aside the ?pay down the debt' alternative, when should management retain earnings and reinvest them in the company, and when should management distribute the earnings as cash dividends ? Arguably, the best reason for paying cash dividends is that management knows that no positive NPV investments exist for the firm. Therefore, rather than keeping cash in the company, where it earns no return, the managers should distribute it to the owners of the company as cash dividends. The owners of the company can then use these cash dividend payments to invest in other companies that have positive NPV projects available to them. Thus, they would be able to create jobs and economic growth for the economy as a whole were they to receive the funds-essentially the public policy objective of a well-functioning corporate governance system . This hypothesis is called the residual theory of cash dividends. If conglomerates were actually following this policy, though, we would detect much more volatility in year-to-year cash bonus payments than we do in reality-volatility that would be more similar to that observed in net income and earnings per share (Drucker, 1984; pg. 156).

Corporate Social Responsibility Initiatives

Corporate social responsibility is likely to mean different things in different business settings and periods. As an idea, it emerged initially in the 1960s among multinational companies from America and those involved in past colonial states in Africa and Asia. U.S. corporations such as IBM, and Xerox in its former day, with marketing companies throughout the world, created concepts of stakeholder relations to justify their positions as foreign companies engaged in new markets (Carroll, 2001; pg. 65). It also grew as a response to the American civil rights movement in the 1960s and 1970s and declared for economic justice in the troubled U.S. cities and later in the conflicts in UK inner cities.

Those multinational enterprises engaged in commodities and natural resource expansion evolved the concept in the face of continued threats to post-colonial investors, nationalization and an all the time more negative environment for business. Several, in any case, had a long tradition of first-rate business standards and active, if paternalistic, community support. The weight was on companies to validate their presence, and the little interest taken in business at that time by the UN system was essentially negative in its approach to multinational enterprises, some of whom had been vindicated in engaging in 'political interference'. A few of the first social impact studies come into view at this time, focusing on economic, social, and human development contributions and far less on environment which had not yet materialized as a significant concern.

In the mainstream, corporate social responsibility was seen as a self-protective shield at times when business and its property were under risk. It surfaced in a similar form at the time of rigorous anti-apartheid campaigning against South African investment in the 1970s, with calls for pulling out of the investments and a burden on demonstrating the contribution(s) that could be made by a sustained presence (Lunnie, 2007; pg. 167).

Throughout these years, corporate responsibility, sometimes used interchangeably with 'corporate citizenship', was often equated with corporate philanthropy as there were a large measure of community support and charitable donations involved in action, whether in the regeneration of U.S. cities, the building of schools and health centers or the funding of scholarships (Carroll, 2001; pg. 11). To this day, U.S. corporate and foundation behavior, habituated to major roles as a donor in U.S. society, sees corporate responsibility largely as a philanthropic strategy, whereas a European model is up-and-coming with far greater emphasis on non-philanthropic activity. Japanese major company behavior has often followed in the footsteps of the American model, even though it gives considerable emphasis to its supply chain contributions (Guerra, 2004; pg. 3).

According to the view of social responsibility as social responsiveness, socially responsible behavior is preventive rather than restorative. The term social responsiveness has become widely used in recent years to refer to actions that go beyond social obligation and social reaction. The qualities of socially responsive behavior include taking stands on public issues; expect future needs of society and moving toward pleasing them, and communicating with the government on the subject of existing and anticipated socially desirable legislation (Drucker, 1984; pg. 67). Corporate managers, according to some analyst's views, use their skills and resources in resolving an existing or anticipated problem. This view as a result, places managers and their corporations in a spot of social responsibility, very distant from the customary one that was worried only with economic means and ends.

Events during the 1980s toughened the attitude that corporations must act in response to problems created by their own proceedings. More importantly, the 1970 crisis kicked off the idea that corporations have to be practical and should be responsive to a wide range of social problems since they have the expertise and power to do so. The present debate on the social accountability of business is not worried about obligatory behavior but with socially receptive behavior.

The proliferation of product certification schemes touches many of the issues. A broad government-backed mechanism emerged to certify that international trade would be free of "conflict diamonds" associated with human rights violations in Africa. Exports of soccer balls and rugs from South Asia feature certification processes to assure the goods were not produced using child labor. "Green" labels tout the environment-friendly record of many products, from recycled paper or plastic products to energy-saving devices to "dolphin-safe" tuna (Guerra, 2004; pg. 5). Remarkable variety exists in the types of issues addressed and certification measures employed. The constellation of certifying and supporting organizations can also mix public agencies, business organizations and civil society groups.

Fair Trade initiatives represent a particular application of product certification schemes, usually but not exclusively applied to products based on agricultural commodities. The basic concept seeks to establish a dependable, long-term relationship with commodity growers in developing countries, offering them a higher price for their products by eliminating middlemen traders. Many schemes also provide an additional premium to growers for using environmentally friendly methods and/or for community social development projects. The general approach reportedly stems from efforts begun in 1986 by the Max Havelaar Foundation in the Netherlands to respond to desires for development projects that emphasize trade rather than aid. Starting with coffee and expanding to honey, bananas, tea and orange juice, the Foundation supported Fair Trade products sold primarily in Europe. During the 1990s fourteen other Fair Trade organizations were established, reaching over $200 million in sales by the end of the decade (Guerra, 2004; pg. 11), still largely concentrated in European markets. Some approaches expect consumers to pay a somewhat higher price for certified Fair Trade products while other efforts try to remain price-competitive, using cost savings in the distribution chain to redistribute profits toward developing country growers (Lunnie, 2007; pg. 19).

An important extension of the Fair Trade mechanism to the U.S. market occurred in 2000 when Starbucks announced the introduction of a blend of Fair Trade coffee certified by the non-profit TransFair organization that encourages farmer co-operatives in developing countries to sell direct to coffee roasters or retailers. The breakthrough with Starbucks came after some of its coffee houses were vandalized during anti-globalization protests at a World Trade Organization meeting hosted in the company's hometown of Seattle, Washington. This initiative complemented Starbucks' broader social responsibility programs and helped expand Fair Trade coverage in the United States beyond craft shops and a few grocery stores. Subsequent discussions between Starbucks and Oxfam also led to cooperation on a project to aid coffee growers in poverty-stricken areas of Ethiopia.

Wage standards represent one of the most problematic labor issues in code of conduct debates. The wage debate revolves around the question of where to set an ethical minimum wage rate. Traditional choices involved either the local legal minimum wage or the local industry market wage (that may fall below the legal minimum where laws are not well enforced). In many developing countries, neither choice appears ethically acceptable to civil society groups. Governments over and over again set legal minimum wage rates low as a motivation to attract foreign investment and encourage labor-based exports. In these countries, surplus labor acts as a spirited economic factor donation, meaning market forces of supply and demand also contain wage rates. Under these conditions, either standard can leave workers with inadequate money to live, even significantly the local poverty line.

The concept of a living wage attempts to address this issue by setting an ethical minimum wage rate based on a worker's survival needs rather than other possible distributive justice standards such as contribution (productivity), equality, seniority, etc. The normative argument draws on the employee's position as a central stakeholder to whom the firm owes a strong social responsibility (Drucker, 1984; pg. 2). A major difficulty, however, lies in defining "living wage." For example, while providing enough money for minimum survival requirements appears reasonable, agreement rapidly disappears as the list of included items lengthens: food, clothing, housing, health care, transport, education, savings, etc. If a list of items is agreed and priced by the local cost of living, troublesome questions still remain regarding, for example, whether a worker's salary should provide only for that person or also for family members (spouse, children/how many, extended family). Wage-related standards may also clash; for example, two workers, one single and the other the head of a large family, might need a different minimum living wage, but such a disparity in their lifestyles would conflict with an equal pay for equal work standard.

Chapter Four

Conclusions

Many companies, including mining conglomerates object to extending social responsibility beyond the direct employee relationship, particularly in cultures where large extended family ties are common and important. Living wage standards, particularly if liberally defined, could quickly push labor compensation far above local law or industry market levels, leaving the firm at a competitive disadvantage. Losing their low wage rate benefit could also force investing or purchasing firms to look somewhere else for a production site, leaving the workers with no wages. Companies also raise disputes over the fact that those governments or other social institutions should be accountable for providing individual minimum income requirements; employee wage rates should be laid down by market forces that react to worker productivity (input to the production process). The response from critics often relies on the theory that corporate social responsibility becomes manifold where market forces do not work efficiently and governments are unproductive or unresponsive to the needs of their people situations that mark many developing countries.