The Financial Accounting Standard Board (FASB) of USA had recommended that stock options be expensed out to achieve greater accounting clarity and transparency. While this indeed is a move to strengthen corporate governance and restrain managerial excess, the downside is the fear that stock options would get extinct. Consequent to the FASB’s move, several progressive companies have either expensed out stock options or have shifted to stock grants or stock ownership plans. But now, it appears that FASB’s shall not be the last word. The US Congress is looking at a compromise that will satisfy some part of FASB’s logic as well as industry’s pressure to let the stock option instrument survive. It is reported that a Bill has been approved by the House Committee of the US Congress that requires companies to write off stock options granted to the CEO and the top four executives only. Several developing countries, such as India, have been moving towards norms, guidelines and standards to have all the stock options expensed. The twist to the tale by the US Congress may indeed provoke others also to arrive at a compromise formula. Even so, progressive companies which have already started the practice of expensing out stock options must continue it as a good measure in corporate governance than be tempted by the reprieve likely to be provided.

Editor

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Executive Perquisites – Do they affect
efficiency and shareholder value?

by
Dr. YRK Reddy

Why does the CEO travel first class air accompanied by his spouse, gets booked at a super luxury hotel in which he can entertain anyone at company cost and, on return, gets picked up by his chauffeur driven limousine to get to his swanky office for a luncheon meeting in his private dining room? Does it help the company or is it just managerial excess that the shareholders pay for?

A notable research on perquisites, a human resource management issue, was published at an unlikely organization, the National Bureau of Economic Research (NBER of USA) and by even more unlikely researchers – the renowned Dr. Raghuram Rajan, now the Chief Economist of International Monetary Fund and Dr. Julie Wulf, an economist at Wharton School. This indicates the growing importance of managerial remuneration, incentives and perks in the context of industrial organization economics and corporate governance. In the working paper published in May 2004, they have discussed the results of data from 300 large companies supplied by Hewitt Associates.

The main finding was that there is inconclusive evidence to show that perquisites only result in private benefits to the incumbent and on the other hand, it might support the argument that perks may improve productivity. They support perks in the case of mature cash rich companies who do not have investment proposals. Despite the ambivalent conclusions, the study underscores the need for greater understanding of the practice of corporate splurging.

Complementing the arguments in the study, in my view, there are four possible propositions to examine perquisites. Firstly, that perquisite are primarily meant as private benefits that are attractive to management but of no value to the shareholders. Why do managers prefer perquisites instead of cash, especially as the latter is fungible? Managers may prefer perquisites because (a) their value is hidden and investors are less likely to discover them; (b) there are tax advantages associated with perquisites vis-à-vis cash due to lax application of taxation principles and their implementation by the authorities, and (c) because they give the status and authority both within the organization and outside.

The second and third propositions will arise if one were to ask the management for their rationale for giving perquisites. The universal response would be that these are necessary for attracting and retaining talent and hence fulfill the function of achieving external equity in the market (this aspect was ignored by Rajan and Wulf). That they indeed provide the essential extrinsic reward or even “hygiene”. It is, of course, impossible to validate this proposition as compensation surveys that give information adopt a welt of assumptions, including self-serving samples and assert more than analyze. There is suspicion that managers, may push up perks with the help of the consulting firms, even if inadvertently.

The other argument would be that some perquisites are necessary to enhance the productivity of the managers. (It is another matter that several highly productive individuals, such as Narayana Murthy travel by economy). A similar explanation can be given for providing a chauffeur driven vehicle – an additional explanation rendered by one organization in India was that the company wanted to avoid the risk of executives getting involved in traffic offences and accidents. Some companies have contrived explanations asserting productivity benefits from perquisites such as the spouse accompanying the employee officially, private dining hall, casual entertainment budgets and the like.

Connected to the productivity argument, some would state that the perks give the necessary status and power required to transact business efficiently. After all, who would want to talk to someone driving in an auto-rickshaw for a critical meeting? He would not even pass the receptionist for 30 minutes. Power being mostly symbolic, perks are the only means to exercise such power especially on the outside world, they would argue.

The explanations on grounds of productivity may not actually withstand much scrutiny as the basis of these perquisites is not so much the potential for productivity increase among the employees but the pay grade or designation or level in the hierarchy. The argument that perquisites enhance status and power is also questionable as they may not be compatible with flatter organizations such as those in the IT industry which aspect was eminently discussed by Rajan and Wulf. Additionally, one may discover that status and authority can be given with alternative and less expensive methods such as fancy designations, ribbons, honors, medals, trinkets and greater delegation of authority. Of course, these cannot be shown off as easily as a great looking car!

The fourth proposition arises from the perspective of corporate governance. In the context of the principle-agent theory, lax governance will result in managers padding their own perquisites and other benefits. Managerial remuneration and perquisites has become a hot subject in market economies because the shareholders are expected to challenge the management and arrest tendencies for managerial excesses. In the absence of such shareholder activism or strict controls by the dominant owner there is indeed a possibility of a runaway compensation system that will have little relationship to logic. Rajan and Wulf do not find evidence of managerial excesses at the cost of other shareholders.

Contrary to this, there have been arguments to show that some perks indeed reduce shareholder value. For instance, a study by David Yermack of Stern School concludes that firms permitting CEO aircraft use under-perform market benchmarks by about 400 basis points per year and that such firms have excess staffing and may be less profitable than their counterparts.

It is evident that, companies have been doling out perquisites as a desirable practice without examining deeply their rationale, implications and larger costs. This universal practice appears to be self-perpetuating and founded on assertions than on any acceptable principles. Evidence from research also is at best ambivalent. It is time that the corporate governance builds the key principles that must guide companies in devising and accepting a set of perquisites.

The reality of globalization is by now evident to every one, and even though the Doha Round of trade liberalization has proceeded less than smoothly, and even though the anti-globalization lobbyists have highlighted the hazards, the challenges of global market competition will not disappear – certainly not for companies in developing countries nor even for American cotton growers and European dairy farmers. The slowdown in multilateral trade negotiations could well lead the way to accelerated bilateral and regional arrangements, which mean that developing countries will still have to face up to the realities of loss of protection resulting from a changing trade policy environment which forms a large part of globalization. But ‘globalization’ is a multi-layered process which operates at different speeds, at different sub-global as well as global levels, at different dimensions (economic, technological, cultural, environmental and human) and still allows different customs and practices (the slogan “think global, act local” has become conventional wisdom).

Hence there is no question that globalization is a highly complex and inexorable process, and that enterprises must be competitive in the face of global competition if they are to survive. Therefore, the problems for corporate executives are how to understand the complexities, how to manage them, and how to restructure their company so as to ensure not only its survival but also its prosperity. And while these problems confront corporate managers most directly, they are of vital concern to government officials and citizens alike – the survival of a company in the global market means the continuation of employment to support families, and the prosperity of companies means rising standards of living, while the costs of closure can be extremely high in terms of job losses, poverty, national economic capacity and instability. The fact that a company may have been competing successfully in international markets is no guarantee of future success under different terms of trade – there are many examples of companies whose success in overseas markets was dependent on their protection in their home market by a supportive government, so that they were left in an exposed position when government changes of policy changes removed their customary protection.

This article outlines a planning framework which is designed to promote enterprise level competitiveness by targeting the interface between international trade policy and business strategy. The purpose is to assist corporate executives to check the ability of their company to withstand the challenges of the changes in the global trade policy environment, and to develop a business strategy to enhance their company’s competitiveness in the global market. The particular feature of this framework is that it seeks to incorporate the impact of changes in the macro-economic and trade policy environment on the competitiveness of companies. The framework is based on the experience of companies in Commonwealth and non-Commonwealth companies which have been coping with the opening up of their domestic markets to vigorous international competition and the liberalization of their trade regulations, and has been used in Commonwealth executive training courses and advisory assignments dealing with competitiveness and he management of globalization. The framework is also designed so as to structure the application of advanced analytical techniques to fit into a flow of information for decision making, rather than to blind decision-makers with an excess of science. The use of advanced analytical techniques conflicts with the principle of KISS (Keep It Simple, Stupid) which is popular with many senior officials and decision makers, but these days there is no alternative for decision makers to have a knowledge (if not a detailed understanding) of these advanced technique – not least so that they know when the technical information which is preferred is flawed or irrelevant. The focus is deliberate: while corporate executives are experts in their own products, services and market segments, and while they are well versed in the wide range of concepts and techniques of management to improve the competitive position of their company in its own market, they generally tend to have less understanding of the international economic and political environment, and of their national macro-economic environment. The experience of the writer (both as a government policy adviser, a company executive director and as a management consultant) is that company directors are at their weakest when understanding and dealing with the external policy environment, and that they are not always as strong as might be expected when preparing their corporate business strategies. There are too many cases when a business strategy consists only of a SWOT analysis (Strengths, Weaknesses, Opportunities, and Threats) and a business plan based mainly on financial projections of current business operations. There is often little understanding that the SWOT analysis (as conceived by Michael Porter) was actually the last stage of an extensive dissection of the whole business sector and of the strategic positioning of the company in its sector, and it is very rare that there is any evaluation of the changes in the policy environment other than forecasts of interest and exchange rates, usually provided by the company’s bank.

Although this framework is designed as a tool for corporate executives, it can also be used by officials who need to design micro-economic policies to support enterprises, because just as corporate executives lack knowledge of the policy environment, the officials and politicians who determine the macro-policies invariably lack a thorough understanding of enterprise-level market conditions and management methods.

Indeed, it can be said that one of the constraints in the formulation and implementation of effective globalization is a perceptible three way gap between the knowledge and skills of international trade policy analysts and diplomats, of national economic policy officials and politicians, and of corporate executives, especially executives in developing countries and emerging markets who often feel the brunt of global competition, especially from multi-national companies. The trade policy analysts have become almost an international profession of governmental and inter-governmental policy-makers and lobbyists (and some of the most skilled are engaged not by governments but by the industry associations and large corporations of the industrial counties). Their language can be described as a combination of post-doctoral economics and subtle diplomatism, which is not always translatable by outsiders (‘diplomatism’ itself reflects a terminological shift over the past decade whereby members of the Corps Diplomatique have become diplomatists rather than diplomats). But while trade policy analysts are well versed in international affairs and have a global and long term perspective, they do not always have extensive experience at the grass roots of a country, whether in a constituency, a factory or a farm. The national economic policy official and politicians who are involved in international trade negotiations invariably have a good grasp of the macro-economic priorities of their countries and a sensitivity to constituencies (both electoral and interest groups), but not always of the micro-economics and management methods effecting factories and farms. And the managers of the farms have a good knowledge of their product, their market segment, and their professional standards, but not usually of the national economy and still less of international trade. It should be emphasized that these gaps do not reflect any lack of capacity of the various groups, but the reality that their priorities and pressures require them to focus on their immediate responsibilities and do not allow the time to investigate other factors effecting their work, until these are forced upon them.

Competitiveness

A framework to assist companies to survive and thrive in the global market obviously relates to government competitiveness policy and to business competitiveness strategy. Competitiveness was a priority topic in the early 1990’s, when globalization clearly came to dominate the policy and business agenda, after the collapse of the Former Soviet Union overcame many political constraints, and transport and communications technologies further reduced economic constraints to international trade. During the 1990’s almost all OECD countries developed national competitiveness strategies (many inspired by the ideas of Michael Porter), as did a number of emerging market economies. However, while competitiveness has become embedded in the policy agenda of most governments and on the boardroom agendas of most companies in the OECD countries, it still tends to be the exception rather than the rule in the government and companies of developing countries – it appeared to be more a passing fashion, recognized, utilized with donor support, but rarely institutionalized. There are several international ratings systems for country competitiveness, possibly the most notable being the World Economic Forum Annual Competitiveness Index, which, like most other indexes, covers mostly industrial and emerging market countries. This low priority to competitiveness policy among developing countries may prove to be a weakness as the trends towards bilateral and multilateral trade liberalization increase, and in any case competitiveness is not a static policy or management practice: it needs to be regularly updated by governments and companies alike.

As a starting point it is useful to revisit the concepts of competitiveness and assess whether the country’s and the company’s concepts are up to date and appropriate to the current needs. Traditionally, the ideas of country competitiveness were based on Ricardo’s theory of comparative advantage, and it is evident that many policy analysts still argue in these terms. But there has long been a distinction between static comparative advantage of basic factor endowments for production, and dynamic comparative advantage which recognizes that critical factors of invention, production or distribution can be developed. Both economic and management theory have recognized distinctions between comparative advantage and competitivenss, and the conventional concepts of competitiveness were based on productivity rates, the effective wages rates and exchange rate, and on the price elasticity of product substitution.

However, concepts of competitiveness have moved on, and it is essential for government policy makers and company executives to keep pace with the changes. The work of Michael Porter and other management theorists has shown that company competitiveness is much more complex than traditional ideas of comparative advantage and reflects a wide range of ‘hard’ and ‘soft’ factors, and the core competence of the company to manage all these. The World Economic Forum (WEF) notes the distinctions between country and company competitiveness, between factor-driven, investment-driven and innovation-driven economies, and emphasizes that competitiveness is much more than the conventional focus on the trade balance, current account, terms of trade and exchange rate. The WEF also emphasizes the important difference between the current competitiveness of a country “representing its ability to utilize its existing stock of resources efficiently, supportive of high levels of prosperity” and its growth competitiveness “representing its capacity to achieve sustained economic growth over the medium term, controlled for the current level of economic development”. The OECD definition of competitiveness can be adapted for countries and companies: “the degree to which, under open market conditions, a country (or company) can produce goods and services that meet the test of foreign competition while maintaining and expanding domestic real income (or company value)”.

The attention of this article is on enterprise-level competitiveness policies and instruments, both because it is considered that these are in fact the most effective methods of boosting competitiveness in the short term, and because most government policies, especially in developing and merging market economies, have concentrated on the macro-economic policy environment, even though many independent policy analysts highlight the importance of non-economic factors such as the quality of public institutions and public sector reform, low levels of corruption technology and the capacity for innovation, as essential factors for competitiveness. In particular, many countries have emphasized market liberalization to promote competition, and to a lesser extent technology, training, and micro-economic policy instruments such as benchmarking. It is surprising how often enquiries about ‘competitiveness policies’ are interpreted as synonymous with ‘competition policies’. However, changes in the policy environment have not always been followed by equivalent improvements in competitiveness at the enterprise level, and increased competition has not always resulted in the increased competitiveness of national companies but in their collapse – not necessarily due to their intrinsic unviability but because they were unprepared for the new conditions and the combination of intrinsic unviability but because they were unprepared for the new conditions and the combination of superior quality or lower price of imports. There is no argument that macro-economic policy reforms and increased competition are essential, but there is a question whether they are sufficient to galvanise national companies to achieve a turnaround in their operations such that they can compete with the best in the world. Hence, there is a need to gain more of a balance between the macro-economic and the enterprise-level policies, and also to encourage more action at the ‘meso-level’, covering industrial sectors, market segments and industry associations, as well as micro-economic and management methods to promote competitiveness.

The Macro-Policy Framework for Competitiveness

Essentially, effective competitiveness policies require a “Liberalization Plus” approach. Liberalization to remove market distortions, encourage competition and allow the private sector to operate efficiently under market disciplines is a prerequisite, but there is an additional need for policy coordination and for promotional policies to accelerate structural changes. An earlier publication by Ganeshan Wigneraja has outlined a Commonwealth policy framework for national competitiveness as consisting of a package of policies and policy instruments, which may be briefly summarized as follows:

Various countries have emphasized different policies as the mainstay of their competitiveness strategies. Some countries place a great weight on science and technology, others on industrial management instruments (such as quality, process benchmarking, industrial clustering and supply chain management), others on human resource development, and others (as noted above) on liberalization of the product, financial, factor and labour markets. Michael Porter’s ‘dynamic diamond’ for national competitiveness emphasized the relationship between four main components: first, company level strategies, structures and competition; second, factor conditions; third, market demand conditions; fourth, related and supporting industry clusters.

Management Methods for Company Competitiveness

The literature on company competitiveness is enormous, and covers almost every aspect of management from strategy, to financial engineering, production engineering, marketing, distribution, sales and knowledge management. There is clearly too much to synopsise, and indeed the purpose of this article is not to summarise the most effective management methods but to develop a framework for how they can be used best to deal with the challenges of a changing policy environment – when and where to use the various methods, rather than how to use them. The reason forthis is not simply the need for brevity but the need for executives to have a framework to assist in applying the plethora of management ideas and tools. Executives often bemoan the ‘alphabet soup’ of a succession of new ideas which are abbreviated for convenience (the Three Cs, Seven S’s, Six Sigma, Triple Bottom Line, Boston Matrix and so forth) but still overwhelm by their sheer number, and sometimes by, it has to be said, the repetition of the same ideas under new initials.

The Enterprise-level Policy Framework

The enterprise-level policy framework is designed to be comprehensive, with four key elements:

• the scope to link business strategies to changing economic, political, social, environmental policies, and fill the gap between the macro-economic policies and micro-management methods
• a structure of three main parts and ten basic modules, each covering all the relevant policy and strategy issues; these modules can then be reduced, expanded and adapted according to the particular needs of the enterprise;
• a sequence to form a critical path, so that changes are implemented in a step by step chain of cause and effect, or through parallel but linked change programmes;
  · A strategy for company restructuring, so that by the end of the whole process the company should be thoroughly prepared and positioned itself for the changes.

Framework for Managing Restructuring for Competitiveness at Enterprise Level:

1. Short Term Survival:

• Turnaround Plan

2. Business Strategy for the Company’s External Environment

• Policy environment analysis
• Technology analysis
• International viability of the business sector
• Domestic business environment analysis
• Market strategic positioning analysis

3. Corporate Plan for the Company’s Internal Environment

• Review of company operations
• Business plan
• Organization architecture, structure, and culture

Implementation and change process

4. Monitoring, Appraisal, and Evaluation Systems

The importance of the sequencing is demonstrated by the fact that typically, most companies focus their strategic planning efforts on their Business Plan and their internal organization, very often based on their current business operations and market conditions. This comprehensive structured and sequential approach demonstrates that a very large amount of preliminary work must be completed before the Business Plan is actually commenced, so that the plan is actually the end result rather than the starting point of a holistic review process.

Conclusion

The application of a restructuring framework such as this can help to ensure that the implications of the government’s economic policy reforms, in particular trade policy liberalization, and of the changing global market, can be factored into conventional business strategy. This framework is designed not as a prescriptive formula, but as a generic model, which can and should be modified to suit the conditions of a particular country and the needs of a particular company. The application of the framework is not an easy task – but company executives would not be paid high salaries if their job were easy. Globalization is not generous, and the downside of not facing up to its challenges are corporate collapse and the end of salaries for executives and all staff and their families.

(Extract from paper presented at the CACG Directors Programme in Kerala, India in February, 2004. Readers may contact us for full paper)