International Disclosure Practices on Directors’ Remuneration – Empirical Evidence on Public Listed Companies in Malaysia

International Disclosure Practices on Directors’ Remuneration – Empirical Evidence on Public Listed Companies in Malaysia ABSTRACT This study examines the level of disclosure on directors‟ remuneration, one of the important areas of research in corporate governance and reporting disclosure. By selecting directors‟ remuneration as a sample of information disclosed, the objective of this paper then to explore the level of corporate disclosure by Public Listed Companies (PLCs) based on various international code of corporate governance. As the revenue from the domestic market already saturated, it is strongly encourage for PLCs to expand their operation globally. Therefore, PLCs has no option other than raise their reporting practices to the highest level to meet the expectation of the international investor and regulator. The assessment instrument called Directors‟ Remuneration Reporting Scorecard (DRRS) was developed to assess and evaluate the level of compliance on directors‟ remuneration disclosure. Overall finding shows that majority PLCs scored low marks on the attributes tested in the survey. The result of the study suggest that PLCs in Malaysia still lag behind the rigorous and strict requirements in reporting information beyond mandated disclosure requirements.

Keywords Directors’ remuneration, international compliance, corporate governance, disclosure

1.0 INTRODUCTION Directors‟ remuneration is one of the most important mechanisms of corporate governance to regulate the behaviour of the company‟s directors. It also plays significant influence to attract not only local but also foreign shareholders and investors to supply fund for the company. Arguably, excessive remuneration paid to the directors will make the company‟s less attractive as it will reduce the profit of the company and hence, shareholders value. The long-time unresolved problems for the shareholders before they make wise investment decision is the knowledge gap between them and the management regarding what happened in the

company. Not only matters on remuneration, the other aspect of the company include operation, management, governance, risk management, internal control and most importantly financial should be adequately disclosed. If the details of these aspects are not disclosed, the shareholders‟ can only make mere estimates which provide opportunity to the directors to maximizing their own interest rather than shareholders. Therefore, there is a need for company to disclose much information not only to shareholders but the other stakeholders to ensure them understand the business and avoid any misrepresentation. This include sufficient information on directors‟ compensation as this may influence the way managers take the action that are goal congruence with the shareholders‟ objectives. The level and quality of such disclosure become more important if the company trade internationally. Thus, the objective of the present study is to explore the level of disclosure of directors‟ remuneration with the international best practices. The study is significant as it examines the preparedness of Malaysian PLCs to face one of the global governance issues that widely debatable by practitioners and academicians and to evaluate whether PLCs already comply with various requirements of international code of corporate governance.

2.0 REVIEW OF LITERATURE The main theoretical framework to support directors‟ remuneration as a tool for Corporate Governance mechanism is the agency theory introduced by Jensen & Meckling (1976). This classic theory examines the relationship between principals and agents. In the business context, principals refer to the shareholders and agents refer to directors. The complexity of the role of directors means that shareholders unable to closely monitor the work of directors, making directors pursing their interest rather than serving shareholders. Thus, the theory suggests that remuneration as one of the way to motivate and align the shareholders and director‟s interest that will bring win-win situation for both parties.

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Realizing this, many countries and international organization recognized director‟s remuneration as an important subject of disclosure by the code of Corporate Governance. In the UK, the requirement to disclose information on directors‟ remuneration first highlighted in the Cadbury Report (1992). The report insists the shareholders have the right to know present and future payment of directors including the stock, option and pension contributions. Later, comprehensive disclosure guidelines were discussed in the Greenbury Report (1995) that requires extensive disclosure on policy of remuneration including levels, comparators‟ companies, individual components, performance criteria, pension, contract service and compensation on early termination. In addition, full disclosure also demanded for all components of remuneration for individual directors and any schemes granted to them such as share option and its justification of entitlement. The requirements to disclose such information become effective when companies in the UK are required to comply with The Directors‟ Remuneration Report Regulations 2002 that clearly enforced the directors to publish the directors‟ compensation report. This report should explain in details consideration by the directors of matters relating to directors‟ remuneration, policy, performance graph, service contract, amount, significant remuneration to past directors, consulting fees, pensions and long term incentives scheme. In the US, the Securities Commission (SEC) provides guidelines on director‟s compensation by issuing the Executive Compensation and Related Part Disclosure in 2006. In addition to the UK‟s requirement, this rule requires the companies to have a narrative discussion and analysis on overall compensation, clear and reader friendly of compensation table that details out every component of remuneration for every single director, supplementary tables to further explain every information related to remuneration, post employment compensation and differential treatments to different type of companies. It was clear that these two developed countries put directors‟ remuneration as an upmost importance aspect of the Corporate Governance practices. It intended to provide investors with a clearer and more complete picture of the

compensation earned by a company‟s principal executive officer, principal financial officer and highest paid executive officers and members of it board of directors. However, the similar emphasis was not applicable in Malaysia. In March 2000, the Malaysian Code of Corporate Governance was developed with the aims to set out principles and best practices on structures and processes that companies may use in their operations towards achieving the optimal governance framework. No such comprehensive disclosure required on directors‟ remuneration disclosure in which the companies are required to provide brief explanation on directors‟ remuneration in their annual report.

3.0 RESEARCH METHODOLOGY The study aim to evaluate companies‟ practices on directors‟ remuneration disclosure based on global Corporate Governance best practices. Top 500 public listed companies by market capitalization as at 31 December 2005 on Bursa Malaysia were selected and the annual reports published up to the financial year end as at 30 June 2006 were used in the survey (Table 1). The assessment instrument called Directors‟ Remuneration Reporting Scorecard (DRRS) was developed from various international best practices to assess and evaluate the level of compliance on directors‟ remuneration disclosure. This best practices are drawn from international guidelines or codes on corporate governance which includes the Organisation for Economic Co-operation and Development (OECD) Principles, the International Corporate Governance Network (ICGN) Remuneration Guidelines, the Securities and Exchange Commission (SEC) of the United States Executive Compensation and Related Party Disclosure and the United Kingdom Combined Code on Corporate Governance The study scrutinizes the extent of the disclosure as disclosed in the annual report of the companies. The scores of the companies were computed based on a dichotomous scale of “Yes=1” and “No=0”, where a “1-point” score denotes the level of compliance with the Best Practices whilst a “0point” score represents no compliance.

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In total, there are sixteen (14) possible dimensions or attributes of Global Best Practices tested for this study. Thus maximum possible score that could be allotted to each individual company analysed is 14 points (100%) while maximum score for each attribute is 500 points (this also make up total percentage of 100% if all 500 companies complied) indicating whether a listed company is complying or not complying with the said attributes.

Remaining 11 attributes scored poorly less than 30% marks shows that not even half of the companies surveyed disclosed majority of the possible information tested.

4.0 FINDINGS

If the company use third parties in setting up the remuneration, their identity and relationship must be disclosed to avoid any possible conflict of interest with the existing director. Our survey finds that 125 companies (25%) use the consultants to set up the director‟s remuneration policies but none of these companies provide further information such as name, term of appointment, job description appointment and statement assuring their independence.

In general, the level of compliance with international best practices for directors‟ remuneration is unsatisfactory. Majority of the companies fail to achieve minimum compliance score of 50% pass mark on the attributes tested in the survey. The average compliance score for all 500 companies on the all attributes only 20.7%, showing most companies in Malaysia languish at the lower end of global practice compliance. The summary of the findings as per Table 2. Attributes on historical information directors‟ scored the highest marks of 99.4%. This due to fact that PLCs are required by the Listing Requirements to provide comparative figures in their annual report. However, further examination revealed that not many companies show the comparative figures for every components of remuneration. Past information on directors‟ remuneration should be disclosed so that the shareholders able to compare and analyze the current and previous payment to directors with the company‟s performance and director‟s contribution. Half of the companies (50%) disclosed and indicates that long term incentives such as share, option and deferred compensation has been used to reward executives directors. This is however do not correspond with the next attributes in which only 44.8% of the companies further explain and details out the information on stock, option and other types of long term incentives rewarded. The used of this component of remuneration were widely encouraged all over the world nowadays as it can effectively align the contribution and commitment of the directors with the longer interest of the company to maximize the shareholders‟ wealth.

Almost one-third of the sampling companies benchmarked the remuneration with the industry and other companies but majority of these companies do not specify any basis used to link the payment with other companies like variance and ratios.

Only ninety two companies (18%) provide details information on the equity compensation rewarded such as number of securities allocated, price, and number of outstanding securities. This information is important as excessive amount and cost for this component will open the door for directors to manipulate accounting figures rather than concentrate to increase real operating income to push the market price. Eight (8) attributes scored less than 10% marks showing lack of self-efforts taken by PLCs to increase the governance standard up to the international level. The score for these attributes ranging merely from 8.2% to 0%. Surprisingly, none of the company explained step-by-step and methodology to derive directors‟ remuneration payment. It is important for the company to disclose such information so that the shareholders able to justify the rationale of such payment. In term of companies, only 19 companies or 3.8% companies that scored 50% or more with IJM Corporation, Sime Darby and AIC Corporation score the highest marks of 64.3% (9 out of 14 marks) (Table 4) Further analysis by sectors shows that there is no much differences in the marks scored between industries in which in average all industry scored around 10% to 20% (Table 5). The score for companies in the highly regulated industry such banking and finance also very poor in which the

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level of compliance for this companies only 17.8%.

APPENDIX Table 1: Summary Statistics of Compliance Score among PLCs

Finally, similar findings also applicable for the analysis done by the board of listings. Table 6 shows that there are not many differences in the marks scored by the companies listed in these three boards.

5.0 CONCLUSIONS This paper presents findings on the reporting of directors‟ remuneration among the top 500 public listed companies on Bursa Securities. The study find that overall compliance with the Malaysian Code of Corporate Governance is generally satisfactory, but not for international best practices. Most of the companies fail to achieve minimum compliance of 50% while average compliance score for all the companies is only 20.7%, showing most companies still very far to reach high standard of global practices Therefore, much effort needed to improve the reporting practices such as convincing the companies on the invaluable benefits of following the global CG best practices. There is also a wake up call for better monitoring by regulatory bodies to raise the standard of disclosure.

Total (%) 20.7 21.4 12.5 0.0 64.3

Mean Median Standard Deviation Minimum Maximum

Table 2: Sample of Companies by Sectors Sector Closed-End Funds Construction Consumer Products Finance Hotel Industrial Products Infrastructure Project Companies Mining Plantation Property REITS Technology Trading/ Services Total

Main Board 2

Second Board -

26 52

MESDAQ

Total

-

2

2 6

-

28 58

47 4 96

10

1 3

48 4 109

8

-

-

8

1 33 63 2 12 104

2 2 8

11 5

1 35 63 2 25 117

450

30

20

500

Table 3: Global Best Practices in Director’s Remuneration Disclosure & the Average Score

REFERENCES

Dimensions of Global Best Practices

Cadbury Report (1992). Combined Code (June 2003) Greenbury Report (1995) International Corporate Governance Network (ICGN) Remuneration Guidelines (July 2006) Jensen, M. and Meckling, W. (1976) „Theory of the firm: managerial behaviour, agency costs and ownership structure”, Journal of Financial Economics, 3, pp. 305-360. Malaysian Code of Corporate Governance (March 2000) Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance (2004) The Directors‟ Remuneration Report Regulations (UK) (2002) US Securities and Exchange Commission: Executive Compensation and Related Party Disclosure (2006)

1 2. 3. 4. 5. 6.

7. 8. 9. 10. 11. 12. 13. 14.

Historical information Long-term incentives are used for rewarding executive directors Disclosure on long-term incentives Benchmarking Information on consultant Further information on equity compensation such as number of securities, price and outstanding securities. Explanation on benefit in kind Further information explaining make up of the remuneration Company‟s performance as a basis for director remuneration Compensation to the former Chairman/ CEO Formal policy Procedures in developing remuneration of individual directors Future determinants of compensation Method of calculation for remuneration

Average Score (%) 99.4 50.0 44.8 28.0 25.0 18.8

8.2 7.4 5.0 2.0 0.8 0.4 0.2 0.0

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Table 4: Companies that Achieved Minimum Compliance Score of 50% No 1. 2. 3. 4. 5. 6 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19.

Companies IJM Corporation AIC Corporation Media Prima Sime Darby Maxis Air Asia Malayan Banking New Strait Times Press,The Sunrise IJM Plantation Kim Loong Resources Bhd Public Bank United Malayan Land Pharmaniaga British American Tobacco Paramount Corporation Tractors Malaysia Holdings Hyundai Sime Darby Sunway Holding Incorporation

Total Score (%) 64.3 64.3 57.1 64.3 57.1 57.1 57.1 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0 50.0

Table 5: Total Compliance Score by Sectors Sector Technology Property Hotel Trading/ Services Construction Consumer Products Finance Industrial Products Plantation Infrastructure Project Companies Mining Closed-End Funds REITS

Total (%) 21.3 20.2 18.8 18.2 18.1 17.9 17.8 17.3 16.1 14.1 12.5 10.7 3.1

Table 6: Total Scored by Board of Listings Sector First Board Second Board MESDAQ

Total 18.2 17.0 14.7

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