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This purpose of this report is to analyse and advice on how the executive remuneration plan of should be established for the new subsidiary of Sahrawi Autos Ltd (SA) in Germany.
The report starts off with a detailed analysis on the compensation system used in Bayerische Motoren Werke AG (BMW), a company operating in a similar environment to SA.
The report will conclude with a final take on how the new subsidiary should plan its compensation on, taking into context the cultural and financial reporting environment in Germany.
Bayerische Motoren Werke AG (BMW) places huge emphasis on designing remuneration systems that is consistent at different levels. Remuneration is designed to encourage a management approach focused on sustainable development and on the performance criteria. This refers to the nature of the tasks allocated to each member, the economic situation and the performance and future prospects of the BMW. It is noted that everyone at BMW should have a remuneration with a similar structure and components.
The compensation of the Board of Management comprises of a few components: basic salary, variable salary and retirement and surviving dependants’ benefit entitlements.
The fixed remuneration starts with a fixed monthly salary. This fixed salary differs based on their seniority and period in office. BMW provides for variable remuneration whereby bonuses are given. The Supervisory Board derives bonuses by taking into account, on a multi-year assessment, the contribution of each member’s ability to sustain and develop the company. This include various factors such as innovation, customer focus, ability to adapt, leadership accomplishments, contributions to the Company’s attractiveness as an employer, progress in implementing the diversity concept and activities that foster corporate social responsibility as the basis for variable compensation (Bayerische Motoren Werke AG 2013). In addition to this, BMW provides a share-based remuneration programme, in which the amount is based on the bonus paid. This aims to create further long-term incentives to encourage sustainable governance as if shares are held for a minimum of four years, the members may receive additional stocks or cash equivalent.
On top of that, BMW provides the Board of Management with a myriad of benefits such as the use of company and lease cars, payment of insurance premiums, contributions towards security systems and an annual medical check-up. Members can also take advantage of privileges given to purchase vehicles and other services of BMW. Furthermore, members are provided with retirement and surviving dependants’ benefits. The pension is based on the member’s length of service to Company and board (for members appointed for the first time before 1 January 2010) or by amounts credited to individual savings accounts for contributions paid and interest earned.
The Supervisory Board has to ensure that the compensation components of the Board of Management compensation are appropriate, taking into account that the amount given should not encourage the Board of Management to take inappropriate risks for BMW but still attractive in the context of the competitive environment for highly qualified executives (Bayerische Motoren Werke AG 2013). The appropriateness of the compensation system is subjected to review by the Supervisory Board. External independents remuneration experts, investors and analysts are frequently consulted and constantly comparison to the compensation paid by other German publically listed companies are made to make sure that BMW’s remuneration system is in line with its bid to create a fairer and sustainable compensation environment within the company.
Germans are individualistic and likely to act in their own self-interest with disregard to others (The Hofstede Centre 2014). They gives rise to the assumption in the Watts and Zimmerman’s Positive Accounting Theory (PAT) whereby all parties act in their own interest to maximise their own wealth (Watts & Zimmerman 1978). This is detrimental to the shareholders. However, as shareholders are not oblivious to this, they monitor the managers closely and engage in price protection, reducing their remuneration. Therefore, the management have an incentive to bond with shareholders to enter into management compensation contracts that rewards managers for behaviour beneficial to the shareholder and deterring them from engaging in behaviour detrimental to the shareholders’ interests such that the interests of both manager and shareholders are aligned. Such rewards may come in the form of a fixed basis, of results achieved, or a combination of both.
However, due to such rewards, there are ways in which the management still can act opportunistically to maximise their wealth. This gives rise to the Bonus Plan Hypothesis in PAT whereby managers remunerated on the basis of bonus plans are more likely to use accounting methods that increase current reported income. This, coupled with the fact that Germany is highly competitive and results-oriented due to its masculine nature, managers might feel the need to show results so that they appear heroic and successful. By keeping the remuneration system as simple and transparent as possible, this prevents the manipulation of the financial accounts. If the accounting methods are complicated, it would be easy for managers to falsify the accounts. They would choose options that would increase profits and the rate of return on total assets, allowing them to gain from higher bonus pay.
Germany also has high uncertainty avoidance and small power distance. Uncertainty avoidant meant that the society feel uncomfortable with uncertainty and ambiguity (Deegan 2014). Small power distance meant the society demanded justification if power in institutions and organizations is unequal (The Hofstede Centre 2014). If executives receives a salary too high, this increases social tension. Therefore, salary and rewards had to be maintained at socially acceptable levels (Thannisch 2014). With a simple and proper remuneration system implemented, it is clear and easy for other company employees to accept the executive remuneration.
Hence, for Sahrawi Autos Ltd (SA), the new subsidiary can follow closely with the executive remuneration plans put in place by BMW. Compensation of the Board of Management can comprise of two main components: basic salary and variable salary. The fixed remuneration means a fixed monthly salary. Each member would be given a different starting pay, dependent on the length of office and their position held. As for the variable remuneration, SA can use a performance criteria to decide on the amount of bonuses one gets. However, one important point to note is that SA must make sure that the remuneration system is simple and transparent.
To conclude, SA should adopt a simple and transparent remuneration system built on a fixed and variable component for its new subsidiary.
Bayerische Motoren Werke AG 2013, Annual Report, viewed 01 September 2014, <http://www.bmwgroup.com/e/0_0_www_bmwgroup_com/investor_relations/corporate_events/hauptversammlung/2014/_pdf/GB_2013_engl_Finanzbericht.pdf >.
Deegan, CM 2014, Financial Accounting Theory, 4th edn, McGraw-Hill Education, Australia.
Thannisch, R 2014, Reorienting management remuneration toward sustainability: lessons from Germany, viewed 15 September 2014, <https://www.jus.uio.no/ifp/english/research/projects/sustainable-companies/events/conferences/abstracts/thannisch-session6-draftpaper.pdf >.
The Hofstede Centre 2014, What about Germany?, viewed 8 August 2014, <http://geert-hofstede.com/germany.html >.
Watts, RL & Zimmerman, JL 1978, 'Towards A Positive Theory Determination of Accounting Standards', The Accounting Review, no. January.