Managerial Contingent Pay and Risk of Accounting Manipulation

Accounting Theory
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1.Managerial Contingent Pay
The term ‘contingent compensation’ refers to the performance based compensation
used for motivating the executives or managers of a business corporation for delivering
superior performance. The pay for performance part of compensation package developed for
executives can include short-term bonuses or long-term compensation such as stock options
or stock bonuses. The short-term incentives compensation package consists of annual
payments provided to executives on the basis of the company performance. The
compensation committee developed by the Board holds the responsibility of creating the
benchmarks of the company performance in specific categories such as earnings per share,
return on assets or return on equity. Thus, the managers or executives are provided the
bonuses if the corporate is able to achieve or exceed the benchmark. However, if the
determined targets are not achieved then manger or executives are paid small or no bonuses
(Stabile, 2002). Therefore, the pay to managers in such plans is contingent depend on the
corporate achievement of the specified objectives. The long-term compensation of stock
options refers to providing the option holder the right to purchase specific number of shares
at a fixed price on the grant date whereas bonus stock is free stock that provides
compensation to the managers irrespective of the rise or decrease in stock prices on the grant
date. All these contingent compensation strategies are used by Board members for motivating
them to deliver good performance and thus creative value for the shareholders. This si also
ascertained on the basis of agency theory as per which strategic use of contingent pay
improves the manger’s abilities and improved business outcomes as they places greater focus
on improving the corporate performance (Yu, 2006).
However, there is also increased risk for manipulation of accounting information by
the managers for increasing their pay for performance by depicting improved business
outcomes. The business risk that is likely to be induced in the income depiction or stock
returns of the corporations. The managers may adopt the use of unethical practices for
improving the business performances or implement the use of fraudulent accounting practices
for disclosing false financial information through its financial statements. The financial
conditions of a firm has a direct impact on the stock prices and thus largely determine the
long-term compensation of the managers. Thus, by using unethical business practices
mangers may tend to disrupt the financial information for achieving their personal motives
and thus creates risk for deceiving the investors or shareholders as they rely on financial
information disclosed for making investment decisions.
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In this context, it is essential for business organisations to implement strong corporate
governance policies for balancing both risk and benefits for using contingent pay measures
for managerial motivation. The remuneration committee developed by the Board should hold
the responsibility of deciding an effective contingent pay measure that ensures minimum
level of ethical risks. Also, the internal audit committee should review the compensation
package of the executives or managers for identification of any unethical practices on the part
of managers for fulfilling their personal interest. Also, the Board members should adopt the
use of goal-setting theory for designing of contingent pay for executives. The compensation
package should be directed to attain specific and understandable goals and compensation that
are achievable and it should be structured properly to eliminate the possibility of occurrence
of any fraudulent practices (Bloom and Milkovich, 2005).
2.Remueration Report for Woolworths Limited
(a)Short and long-term Pay for Managerial Performance
The short-term pay for performance for managers in Woolworths Limited consist of
short-term incentives plan. The short-term pay for performance is determined on the basis of
pre-determined targets achieved by the corporation on an annual basis. On the other hand, the
long-term pay for performance is decided on the basis of long-term incentives that is divided
on the basis of performance share plan and restricted share plan.
(b) Proportion of the CEO’s pay performance based and what proportion is not
75% of the CEO’s performance is performance based whereas the remaining
proportion of the pay received by the CEO is no based on performance and is fixed.
(c)Measures of accounting performance are used to determine the CEO’s bonus
The CEO’s bonuses in Woolworths limited is determined on the basis of accounting
measures of return on assets (ROA) and return on equity (ROE). These two accounting
measures are based for determining the bonus payments in managerial compensation
contracts (Woolworths Holdings Limited, 2017).
(d)Accounting decisions for CEO to maximise their bonus
The CEO might take the decision of increasing the financial leverage on the company
fo r increasing the return on equity as long as the return on assets is greater than the after-tax
cost of interest. However, it is ethical on the part of CEO for maximising the ROE to improve
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