This paper examines several interconnected issues surrounding employee and executive remuneration in Australia, with a focus on corporate and social ethics. Drawing on agency theory and classical economic theory, it analyzes the risk aversion of managers versus the wealth-maximization goals of shareholders, and how incentive-based contracts attempt to reconcile these competing interests. The paper then addresses the horizon problem — the tendency of managers to prioritize short-term results over long-term firm value — and evaluates equity-based compensation as a partial remedy. Finally, it considers the role of non-salary components in executive pay packages, including how non-cash compensation is structured, why it is used, and the regulatory and ethical concerns it raises for publicly traded companies.
The paper demonstrates effective use of multi-source synthesis: rather than relying on a single authority per claim, it layers citations from Rankin et al., Kolb, Ferrarini & Moloney, and Conyon & Florou to show where sources agree and where they add distinct dimensions. This technique strengthens the credibility of each argument and models the kind of literature engagement expected in undergraduate business writing.
The paper is organized around five broad questions (though the version here covers three in full). Each major question functions as an independent analytical section with its own theoretical grounding, problem statement, proposed solutions, and critical evaluation. This modular structure — common in corporate governance and accounting courses — allows each section to stand alone while still contributing to an overarching argument about the ethics of executive compensation design.
This report assesses a number of subjects surrounding the remuneration of employees and the overall corporate and social ethics involved in Australia. There are also several tangential and related subjects addressed throughout. In total, five broad questions are examined. The first concerns risk aversion, profit and wealth maximization, wealth management, the different stances that various personnel take with respect to risk, and financial reporting manipulation. The second question addresses the horizon problem, exploring the different motivations and perspectives that managers and stakeholders bring to investment and accounting situations. How bonuses for investment managers figure into this dynamic is also explored. A further section examines the non-salary components of executive remuneration — including the purposes served by non-cash compensation and the regulatory concerns it raises. While some observers may simply enjoy provoking debate, there are indeed valid concerns relating to the ethics, motivations, decisions, and biases of investors, stakeholders, and others involved in the accounting and investing functions within an organization.
The underlying assumption of agency theory, which is used to explain and predict behaviours in accounting, is that all individuals will act to further their own self-interest (Rankin et al., 2012). According to Kolb (2010), agency theory indicates that managers, as agents, are assigned the task of day-to-day operation of a company by the shareholders as principals. However, a conflict arises because the self-interests of these two parties are not aligned. Classical economic theory suggests that a higher-risk strategy can result in higher rewards than those achievable through a low-risk approach. Shareholders generally desire higher returns and typically diversify their risk by holding shares in multiple companies, often supplemented by other sources of income (Rankin, 2012). Shareholders seek to maximize their personal wealth, which equates to maximization of share price and dividends — outcomes that increase with higher-risk strategies (Kolb, 2010).
In contrast, managers are likely to follow a risk-averse strategy because their current salary and career prospects are tied to their present employment situation (Ferrarini & Moloney, 2004). Managers are also likely to focus only on short-term earnings that directly affect their current employment (Kolb, 2010). To counter this risk aversion, incentive-based contracts are used to encourage managers to engage in riskier behaviour (Rankin et al., 2012). According to Ferrarini and Moloney (2004), the simplest way to do this is by tying remuneration to performance indicators such as share price. This provides an incentive for management to act in a manner that maximizes shareholder wealth, because doing so will also serve their own best interests. To achieve the outcomes that shareholders desire, executive remuneration therefore comprises multiple elements balanced to minimize management risk aversion. These include fixed base salaries, short-term cash bonuses linked to specific targets, and longer-term target-based incentives including both shares and share options (Ferrarini & Moloney, 2004).
There are many challenges in using contracts to reduce management risk aversion, and striking the correct balance in the use of bonus instruments is critical. Rankin et al. (2012) identify a point at which bonuses in the form of shares can actually serve to increase risk aversion. This occurs because managers will have an even greater portion of their financial position tied to the company, with no ability to diversify. Ferrarini and Moloney (2004) further identify that contracts tying short-term bonuses to share performance can provide an incentive for management to manipulate financial reporting in order to generate short-term share price increases and earnings gains.
The underlying premise that individuals act in their own self-interest also relates to what is known as the horizon problem. Managers will naturally be concerned with improving a company's performance only for the period of time that affects their current employment. This effect is amplified as managers approach retirement, since there is a greater incentive to cut back on long-term projects in order to maximise current earnings (Conyon & Florou, 2006). Managers can therefore be expected to focus on a short-term horizon. Shareholders, by contrast, are concerned with the long-term growth of the company, where the value of the entity is measured in part by expected future cash flows (Rankin et al., 2012). Shareholders desire managers to make investment decisions that will maximise future cash flows (Rankin et al., 2012).
One way to counter the horizon problem is through the use of equity instruments as a component of executive remuneration. Equity ownership and share options encourage managers to care not only about short-term results but also about the future of the firm (Conyon & Florou, 2006). If a manager holds shares and share options that cannot be exercised until after a defined period post-retirement, they are unlikely to engage in short-term, firm-value-destroying actions (Conyon & Florou, 2006).
As noted previously, it is often the accounting measure of earnings that drives the calculation of bonuses paid to managers. Managers can manipulate accounting information in ways that make a company appear short-term profitable. This could be achieved directly — for example, through a reduction in spending on research and development — or indirectly, through reduced depreciation resulting from lower capital expenditure (Conyon & Florou, 2006). It could be argued, therefore, that there must be a reduced reliance on accounting information to drive the calculation of bonus plans designed to address the horizon problem. Managers, particularly CEOs and CFOs, have the greatest ability to manipulate such information. Bonus plans based on share payments and share options force the manager to make decisions that strike an appropriate balance between short-term performance and long-term growth and viability. Conyon and Florou (2006) suggest that this may even act as a substitute mechanism, allowing for reduced monitoring of executive activity.
The foregoing analysis demonstrates that executive remuneration is far more than a straightforward matter of setting salaries. The competing interests of managers and shareholders create persistent structural tensions that compensation design must actively address. Risk aversion leads managers to favour short-term, low-risk strategies at odds with shareholder preferences for long-term wealth maximization. The horizon problem compounds this misalignment as managers approach retirement. Equity-based instruments — share ownership and share options — offer a partial but meaningful remedy to both problems, though they introduce their own complications, including the potential to increase rather than reduce certain forms of risk aversion or to incentivize financial reporting manipulation. Non-salary compensation adds further complexity, serving legitimate purposes while simultaneously raising regulatory and ethical questions. Together, these issues underscore the importance of carefully designed, transparent, and ethically grounded remuneration frameworks for organizations operating in Australia and beyond.
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