ACC8000: Report on Compensation Related Issues - Research Paper by Gold, Gronewold and Pott - Accounting Assessment Answers

November 28, 2017
Author : Julia Miles

Solution Code: 1HFF

Question:

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This assessment task will be testing your individual responses to the questions contained in this document. It will enable you to demonstrate your knowledge and the application of skills relevant to that knowledge, as well as your communication skills.

Requirements:

There are two parts to this assignment. Part I addresses issues in financial accounting and comprises 55% of this assignment. Part II addresses issues in auditing and comprises 45% of this assignment. The word limits for this assignment are Part A 1,650 words (excluding headings, table of contents, in- text references, and reference list) part B 1,350 (excluding in-text references and the reference list). The assignment will be marked out of 100 marks.

Part I

Bill Strong is the founding director and Chief Executive Officer (CEO) of the Strong Built Construction Company. After an extensive executive search, Susan Bold has recently appointed as the new Chief Financial Officer (CFO) of the Strong Built Construction Company. At a recent board meeting discussions arose about profitability and the compensation of executives. The construction industry has been in a downturn due to government austerity measures. Bill has a high public profile and is well-known in the construction industry. His dynamic personality and leadership charisma are attributed to the success of the Strong Built Construction Company in maintaining revenue at similar levels for the last two years, while other construction companies have faced drops in revenue. Although the Strong Built Construction Company has been successful in maintaining its revenue levels, profit before tax has fallen. A recent employee survey revealed falling levels of employee motivation. Members of the board have been questioning the current approach to executive compensation that rewards employees with company shares that are held in trust for three years before employees are able to sell the shares. Bill Strong is trained in economics and argues that the conventional agency theory approach to executive compensation where employees receive monetary benefits helps motivate employees. Susan Bold explains that intrinsic considerations need to be taken into account in determining executive compensation.

Required: You are Susan’s assistant and you have been asked to prepare a report that is backed by scholarly literature addressing the following issues regarding approaches to compensation:

a. Typical elements of compensation packages

b. Outline the key assumptions of traditional agency theory and theirinfluence on approaches to compensation

c. Explain the difference between extrinsic and intrinsic motivation and therelationship between the two motivations

d. How might an employee’s attitude to risk influence their desiredcompensation package?

e. How might the time period when employee receives a financial benefitinfluence they desire for the benefit?

f. What role do fairness considerations have when determiningcompensation?

g. Why an executive compensation committee may provide benefits indetermining compensation.

h. How to structure an executive compensation committee to achieve thebest outcomes.

i. Conclusion: use the information in your previous answers to develop recommendations for determining compensation that enhance job satisfaction and work motivation.

j. Appropriate report formatting (title page, table of contents, introductionand appropriate headings)

k. Adequate in-text references and reference list following Harvard style

Part II

(i) Read the paper by Gold, Gronewold and Pott (2012):

  1. What is the aim of the research paper/project? (3 marks) b. Draw a table to illustrate the 2 x 3 design (p. 292) showing the six groups and the different information that each group received. (6 marks) c. What was the purpose of the manipulation checks?

(ii) Read the study by Agyei, Aye and Owusu-Yeboah (2013); along withthe study by Okafor and Otalor (2013): a. Briefly outline the research aims of each study (4 marks) b. Explain how each study attempts to measure the audit expectation gap and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior in its rigor. (6 marks) c. Explain how each study selects the research participants and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior. (6 marks) d. Outline the response rate in each study and whether you think theresponse rates are adequate in each study. (6 marks) e. Explain how each study goes about analysing the data that is collected and comment on which approach you think is more rigorous, stating reasons why you believe one approach is superior in its rigor. (6 marks) f. Briefly outline two other significant flaws that you have noticed in thestudies.

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Solution:

Part 1 Report on Compensation related issues

Introduction

Compensation related issues occupy the fore front of the Human Resource function of the Corporate and are loosely influenced by the traditional agency theory literature available on motivational theories and the overall culture and leadership style prevalent in the organization along with a host of other issues as discussed herein.

The report accordingly details the underlying issues as instructed, specifically covering the discussion on the elements of the compensation package, influence of traditional agency theory on the adopted compensation policy, discussion on the extrinsic and intrinsic motivation in terms of their linkage and differences, effect of an individual employee’s attitude to risk on the compensation policy , effect of time of receipt of financial benefit on the employee desire and fairness considerations for compensation determination. The report also details the benefits and ideal structure of an executive compensation committee relying on scholarly literature wherever possible. Finally, a recommendation on the compensation that would typically enhance job satisfaction and motivate the employees of the Strong Built Construction Company has been provided at the end.

A Typical elements of compensation packages

    • Basic Salary and wagesforms the largest element of the corporate compensation package. This element is loosely based on prevalent rules and regulations, employee experience, tenure, skill and qualification. Its importance is further enhanced due to its linkage to the variable performance incentives which are normally expressed as a percentage of the basic.
    • Bonusis normally made as a one-time annual payment for rewarding individual performance or group performance for meeting or exceeding set expectations.
    • Long-term incentives normally take the form of employee share and stock options which bind the employee to the Organization for the tenure of the incentive.
    • Health and life insurance secure employees by providing coverage for their health problems and dependants after their death. It positively influences employee motivation.
    • Retirement and Superannuation plans.These are retirement benefits offered to employees after their service tenure ends with the company and are seriously considered by the middle aged and senior experienced employees of the Organization.
    • Leaves and Compensatory offs, this element may not be financial in nature but is perceived as positively motivating the employees for meeting their family and personal commitments for the minimum approved leaves.

  • Miscellaneous compensation and fringe benefits include use of company facilities and privileges like use of transport, phone, and discounted loans for specific uses.

(Editors, 2010)

B Key assumptions of traditional agency theory and their influence on approaches to compensation

The key assumption of the Agency theory in relation to compensation policy is viewing the employer and manager/employee relationship as a principal agent relationship in connection with the service rendered by the employee and the compensation and rewards received thereby. It is assumed that the principal is well aware of the mind workings of the agent to a limited extent. (Foss and Stea, 2014)The theory recognizes this as one of the two important agency relationships; the other being between debt holders and owners. This assumption influences the compensation approach by specifically resolving conflicts of interest between owners and managers in relation to matters of corporate governance and routine strategic decisions. (Referenceforbusiness.com, 2016)

The theory considers compensation as part of the agency costs, important to sustain this relationship and urges decisive action on compensation package. The theory is based on the premises that motivating employees through performance incentive will bring out their best and result in owner employee interest alignment. (Pepper and Gore, 2012) The supporters of the theory also believe that excessive compensation may negatively impact motivation and performance(Bebchuk and Fried, n.d.) The theory is often criticized for rewarding perceived risk management instead of actual risk management even though no empirical link has been established between increased incentive and improved performance. As per research, empirical link has been established between manager influence and compensation policy of the company. (Armstrong, Ittner and Larcker, n.d.) Corporate may approach the desired compensation policy keeping the agent behaviour assumptions of the theory.

C Difference between extrinsic and intrinsic motivation and the relationship between the two

Intrinsic motivation reflects the internal human character while extrinsic motivation reflects external self control. Both motivations are important from the employee perspective though the degree of each may vary depending on the desired level of competence. Empirical research establishes Intrinsic Motivation as positively linked with improved performance, while a negative link was found to exist between Extrinsic Motivation and performance (Lemos and Veríssimo, 2014) Both approach employee attitude to compensation in opposite perspectives.While extrinsic motivation focus on basic salary and wages, bonus, and fringe benefits which are material in nature;intrinsic motivationdeals with the self esteem and actualization needs which increase job satisfaction Intrinsic motivation is regarded more effective than extrinsic due to its focus on increasing employee job satisfaction through intrinsic involvement in theirwork rather than monetary reward or leadership attitude. Evidence also suggests that excess of extrinsic motivation based incentives adversely affects responsible employee/managerial conduct. (Ims, Pedersen and Zsolnai, 2013)The relation between the two can be used to devise a compensation package that motivates employees in both aspects(Academia.edu, 2016)

D Employee’s attitude to risk and influence on desired compensation package

An employee attitude to risk influences his desired compensation package in as a risk taker would not mind a variable compensation package while a risk avoider may prefer a fixed compensation package where the compensation is linked to tenure , experience and skill rather than performance. As per the assumptions of the Motivation-Hygiene Theory formulated by Frederick Herzberg, employees tend to be motivated by factors like qualitative work responsibility, vertical and horizontal growth compared to material Hygienic factors like their compensation package. He noted that the existence of hygiene factors does not motivate employee but their absence has a negative impact on motivation levels.However, the motivating factors have a strong impact on employee motivation. Research suggests that employees/leaders with an aptitude for risk take home better compensation packages compared to their peers and team members. (O'Reilly et al., 2014)

An employee’s perception of risk is more synonymous with hygiene factor and might not greatly impact his desired compensation package provided he is otherwise satisfied with his compensation package. (Managementstudyguide.com, 2016)

E Time period and its influence on employee desire of financial benefit

Empirical research in this direction has not found any evidence that supports a link between the time period of the receipt of a financial benefit and the employee desire for the benefit. It has been found that monetary compensation, time period of receipt of benefit, and before hand knowledge of results does not greatly impact the desire for the benefit and may not motivate the employee. Time period may not impact his perceptions as such. (Locke, 1968) However, long term incentive like share and stock options with a lock in period may induce the employee to hang on with the organization during the tenure of the incentive. Research also suggests that long term incentives may be effective to compensate executives for loss of perceived value but are not very efficient compared to other less risky forms of compensation. (Pepper and Gore, 2014)

F Role of fairness considerations for compensation determination

Fairness considerations normally impact compensation determination to a considerable extent as employees regard fairness as important. They perceive a fair compensation as their genuine right as it encompasses an element of fair compensation depending on their skills, experience and also provides for increase in the price levels through annual salary and increments. Fairness also is perceived in terms of balanced compensation for employees of same grade within the company as well as the industry. (Nature.berkeley.edu, 2016) Fairness is also regarded in terms of balance in rewards, consistency in adopted reward policy and the employee perception of the above. Lack of fair compensation may adversely affect performance and motivation. (HR Daily Advisor, 2013)

G Executive compensation committee benefits in compensation determination

The following benefits are normally perceived where the committee functions

  • Adequate review of the adopted compensation policy from the perspective of shareholders, employees, company and customers such that a fair optimal compensation package is designed. (Hermanson et al., 2011)
  • Adequate evaluation of the compensation, incentive and employee equity plans.
  • Adequate reporting on remuneration and compensation as mandated by Securities and Investment Commission.
  • Adequate examination and approval of each executive’s package, long-term incentives and other fringe benefits.
  • Identification of the total and per head cost to the Company of compensation.
  • Performance evaluation of employee and executive officers for annual compensation review.
  • Consideration of factors like company and employee performance and return for fixing the long term incentives (Biolargo, Inc., 2009)

H Structure of an executive compensation committee for best outcome

The committee ought to be appointed by the company board with due recommendation from the Corporate Governance Committee. The minimum composition should at least be two, one independent non-employee director and one independent outside director. The members shall have the necessary qualification and experience to discharge their role effectively (Reda, n.d.)

I Conclusion and Recommendations for a motivating and satisfying compensation determination

  • Long term incentives, health and insurance plans, leaves and superannuation plans positively impact employee motivation and performance as these elements of compensation package are held in high regard by the employees.

  • The agency theory considers compensation as part of the agency costs, important to sustain this relationship and urges decisive action on compensation package. The theory is based on the premises that motivating employees through performance incentive will bring out their best. Corporate may approach the desired compensation policy keeping these factors in mind.

  • Intrinsic motivation is regarded more effective than extrinsic due to its focus on increasing employee job satisfaction through intrinsic involvement in theirwork rather than monetary reward or leadership attitude. The relation between the two can be used to devise a compensation package that motivates employees in both aspects.
  • An employee’s perception of risk is more synonymous with hygiene factor and might not greatly impact his desired compensation package provided he is otherwise satisfied with his compensation package.
  • Time period may not impact his perceptions as such. However, long term incentive like share and stock options with a lock in period may induce the employee to hang on with the organization during the tenure of the incentive.
  • Lack of fair compensation may adversely affect performance and motivation.
  • An executive compensation committee adequately review the Company’s compensation, incentive and equity plans, duly reporting on executive compensation as mandated by Securities and Investment Commission including a thorough examination of each executive officer’s compensation, incentives and fringe benefits.
  • The structure of an ideal executive compensation committee is normally fixed by the company Board as per due recommendation of the Corporate Governance Committee on the minimum composition and other elements.

Part 2

1 Research paper by Gold, Gronewold and Pott (2012)

A Aim of the research

The aim of this specific research was to conclude and comment on the mandatory explanations of the ISA 700 dealing with Auditors report and the effectiveness of these in contributing to the reduction of the audit expectation gap. This aim was achieved by surveying the auditors and users on their perceptions of the auditor and management responsibility and the effect on the reliability of the financial statements.

B Summary of information received by each group

The research divided the respondent into six broad groups and provided information as follows

 

Auditor group 1

Auditor group 2

Unqualified ISA 700 auditor’s report with mandatory explanation.

 

Unqualified opinion without mandatory explanation.

Financial Analyst group 1

Financial Analyst group 2

Unqualified ISA 700 auditor’s report with mandatory explanation.

 

Unqualified opinion without mandatory explanation.

.

Student group 1

Student group 2

Unqualified ISA 700 auditor’s report with mandatory explanation.

 

Unqualified opinion without mandatory explanation.

C Purpose of the manipulation checks

The purpose of the manipulation checks conducted by the study was the verification of the effectiveness of the mandatory explanation contained in the auditor’s report in terms of the presence or absence of the explanation. This aim was achieved by surveying the auditors and users on their perceptions of the auditor and management responsibility and the effect on the reliability of the financial statements. The purpose was to conclude and comment on the mandatory explanations of the ISA 700 dealing with Auditors report and the effectiveness of these in contributing to the reduction of the audit expectation gap (Gold, Gronewold & Pott, 2012)

2 Study by Agyei, Aye and Owusu-Yeboah (2013) and Okafor and Otalor (2013)

A Aim of the study

The aim of the study by Agyei, Aye and Owusu-Yeboah (2013) was the conduct of an Audit expectation gap study in terms of the expectations from auditors and their actual performance. The study was confined to the country of Ghana.

The aim of the study by Okafor and Otalor (2013) was to broadly research and determine the role contributed by the auditing profession in narrowing the audit expectation gap.

B Measurement of the audit expectation gap

The study by Agyei, Aye and Owusu-Yeboah (2013) measured the audit expectation gap by reviewing questionnaires based on Best, Bucky and Tan (2001) and Bogdanoviciute (2011) suggestions and consisting of closed questions to be graded on the Likert scale from 1 to 5. Twenty auditors and twenty stockbrokers were handed about fifty questionnaires so as to reach a conclusion for the acceptance or rejection of the framed hypothesis. The following hypothesis was examined

  • Auditor’s responsibility in relation to fraud detection.
  • Auditor’s responsibility in relation to the adequacy of the internal control structure.
  • Auditor’s responsibility in relation to ensuring fair and complete financial statements.
  • Auditor’s responsibility in relation to maintaining accounting records.

The study by Okafor and Otalor (2013) measured the audit expectation gap by reviewing questionnaires and through the use of descriptive and statistical analysis on the responses received. Accounting students, teachers, accountants and investing public were handed these questionnaires so as to reach a conclusion for the acceptance or rejection of the framed hypothesis. The following hypothesis was examined

  • The audit expectation gap is not the cause of lack of user knowledge on the legal, regulatory and professional pronouncements concerning auditors.
  • The audit expectation gap is not the cause of expectation from the auditor in respect of his duties.

The study by Okafor and Otalor is presumably more rigorous in its approach due to its non confinement to one specific country and a more comprehensive sample of users. This makes it more relevant and representative. The study is broader in its approach of examining the role contributed by the auditing profession in narrowing the audit expectation compared.

C Selection of research participants

The study by Agyei, Aye and Owusu-Yeboah (2013) selected the stockbroker participants from the Greater Accra region of Ghana randomly from the list of brokerage companies publicly trading on the Ghana Stock Exchange. The auditors were selected from the Central Business District of Accra as the region is presumably the hub of auditing firms of Ghana. The stockbrokers were

The study by Okafor and Otalor (2013) selected the accounting students and teachers of the University of Benin, Benson Idahoan University and Ambrose Ally University, Acoma, Accountants in Practice and the investing public in Edo State randomly.

The study by Okafor and Otalor is presumably more rigorous as the user participants consisting of students, teachers and investors were more representative not only in constituency but also in terms of the number of participants compared to the other study which only surveyed stockbrokers and may have failed to adequately reflect user preferences by ignoring investors and other relevant user groups.

D Adequacy of Response rate

The response rate in the Agyei, Aye and Owusu-Yeboah study was 30 on 50 questionnaires for the auditor group averaging a rate of 60% and 35 on 50 questionnaires for the stockbroker group averaging a rate of 70%. Conclusions were reached on the basis of twenty participants from each group to make the representation weight age equal. The response rate is presumably adequate in terms of the aims of the study. The response rate can also be regarded as fair due to equal weight age assigned to both the groups.

The response rate in the Okafor and Otalor study was 94 on 130 questionnaires overall averaging a rate of 72 %. The response rate is presumably adequate in terms of the aims of the study and is slightly better than the first mentioned study. It may also be recapitulated that the Okafor and Otalor study is more representative in terms of the larger user group it seeks to represent.

E Analysis of collected data for reaching the conclusions

The study by Agyei, Aye and Owusu-Yeboah analyzed the collected data statistically using the descriptive statistical techniques commonly employed. The questionnaires were designed so as to adequately reflect the attitudes of the participants in terms of their specific attributes. Part A was based on questions on the demography of the participants while part B was based on the specific questions covering the aim of the study. The questionnaire was framed on the basis of Best, Bucky and Tan (2001) and Bogdanoviciute (2011) suggestions and consisted of closed questions to be graded on the Likert scale from 1 to 5. The questionnaires were based on the personal administration and the statistical analysis of the responses received was done on a single dimension after arraying on equal interval. Descriptive statistical technique employed was Statistical Package for Social Sciences, (SPSS Version 14.0)

The study by Okafor and Otalor analyzed the collected data statistically using the descriptive statistical techniques of (SPSS 16.0). The study used a parametric statistical method under which Variances were analyzed in detail for the investigation of the relation between the tested variables. Empirical Econometric and regression analysis was employed to test the hypothesis so as to extrapolate the responses. Mann-Witney test was also employed to test the variances. The questionnaires were based on self administration.

The approach followed by Agyei, Aye and Owusu-Yeboah is presumably more rigorous due to the better design and frame of the questionnaire used compared to the Okafor and Otalor study.

F Two other Significant flaws in the studies

Two other significant flaws noticed in the Agyei, Aye and Owusu-Yeboah study apart are

  • An analysis of the study user respondents depicted that 60% had an experience of 5 years or less which undermined the relevancy of their responses in comparison to the more experienced user group. This may also have affected the results in case a more representative sample would have been used.
  • The study employed the technique of purposive for choosing the respondents which nay have rendered subjectivity to the study.

Two other significant flaws noticed in the Okafor and Otalor study are

  • Respondents may have replied to questions without a complete understanding as these were to be self administered. The study results may have been limited due to this flaw.
  • The developed hypothesis ought to have included the detailed attributes of the corporate being audited as well.

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