A Positive Theory of Accounting Policy and Disclosure
Solutions Manual
to accompany
Accounting Theory 7e
BY
Allan Hodgson, Victoria Wise
John Wiley & Sons Australia, Ltd 2010
Chapter 11: A positive theory of accounting policy and disclosure
THEORY IN ACTION
Theory in Action 11.1 Objections to crackdown
1. What are the likely components of a chief executive officer’s (CEO) management compensation package that might be affected by the proposed changes?
It is most likely that the cash component of CEO compensation packages would be increased if ‘caps’ (upper restrictions) were to be placed on other components (such as share bonuses and options) of the packages. The article also suggests that total salary may have to be increased.
2. How is the introduction of a ‘cap’ (upper limit) on termination payments likely to affect CEO’s remuneration if firms make no adjustments to the compensation packages?
Other components consisting of bonuses and equity-based compensation (such as shares or options to acquire shares) on top of base salary is likely to increase, particularly in the period leading up to termination of employment. To provide an incentive to the CEO to outperform the market in the pre-termination period non-salary components of the compensation package may be added to the remuneration package.
The instructor might mention at this point the tie in with agency theory: According to agency theory, agents (managers/executives) are utility maximisers and there is no reason to believe that they will necessarily act in the best interest of principals (shareholders) unless the principals’ and agents’ interests are aligned. For example, managers have incentives to increase perquisite consumption at the principal’s expense. In order to solve this agency problem, shareholders need to align managers’ remuneration with their performance in maximising the firm’s value. By including non-salary components in the CEO’s remuneration package, firms will provide incentives to CEOs to act in a manner
to accompany
Accounting Theory 7e
BY
Allan Hodgson, Victoria Wise
John Wiley & Sons Australia, Ltd 2010
Chapter 11: A positive theory of accounting policy and disclosure
THEORY IN ACTION
Theory in Action 11.1 Objections to crackdown
1. What are the likely components of a chief executive officer’s (CEO) management compensation package that might be affected by the proposed changes?
It is most likely that the cash component of CEO compensation packages would be increased if ‘caps’ (upper restrictions) were to be placed on other components (such as share bonuses and options) of the packages. The article also suggests that total salary may have to be increased.
2. How is the introduction of a ‘cap’ (upper limit) on termination payments likely to affect CEO’s remuneration if firms make no adjustments to the compensation packages?
Other components consisting of bonuses and equity-based compensation (such as shares or options to acquire shares) on top of base salary is likely to increase, particularly in the period leading up to termination of employment. To provide an incentive to the CEO to outperform the market in the pre-termination period non-salary components of the compensation package may be added to the remuneration package.
The instructor might mention at this point the tie in with agency theory: According to agency theory, agents (managers/executives) are utility maximisers and there is no reason to believe that they will necessarily act in the best interest of principals (shareholders) unless the principals’ and agents’ interests are aligned. For example, managers have incentives to increase perquisite consumption at the principal’s expense. In order to solve this agency problem, shareholders need to align managers’ remuneration with their performance in maximising the firm’s value. By including non-salary components in the CEO’s remuneration package, firms will provide incentives to CEOs to act in a manner