Managers are not the real owners of the companies and owners are not the real managers of the companies. However, Managers are appointed by the owners i.e. by the shareholders to take care of companys performance for the owners benefit, but sometimes managers take some decisions for their own sake without having light on the owner's value. This concept is called an 'Agency Problem'. This problem is generally faced by all the companies these days. Executive compensations packages attract the public attention and media interest. The major event was when Vodafone declare in its annual report in 2000 and 2001 that Vodafone's CEO Chris Gent, awarded with £8 million as a salary package (Annual Report Vodafone, 2000). This all happens after firm Vodafone takeover German mobile phone group Mannesmann and Air Touch. After such takeovers and mergers Vodafone underwent major managerial changes; this mainly because according to Guest, P (2006) "correlation between the compensation and size imply that making a firm larger by acquisition could only increase the compensation of an existing managers, regardless of whether the acquisition creates value or not". Therefore majority of acquisition, mergers do not benefit to shareholders but these acquisition and mergers are basically carried out to increase the size of the firm in an attempt to increase executive compensation (Guest, P 2006).
There is significant relationship between firm performance and the level of executive cash compensation. In Vodafone, CEO compensation consist of cash- based compensation, which is the sum of base salary and bonus and equity-based compensation, that is the sum of stock options and long term/short term incentives plans (Ozken, N 2007). According to the Vodafone annual report of 2000, the short term incentive plans is provided in form of shares, after attaining performance criteria for the year as set by the remuneration committee. This provisional award of share is in two parts: "an original award of "Initial Shares" worth up to 25% of salary and an additional award of "Enhancement Shares", worth 50% of the value of the original award" (Vodafone Annual Report 2000). But if executives do not want to go for provisional awards then, the company may pay a cash bonus of 25% of salary. While in Long Term incentive plan shares will be transferred to the executive directors and senior executives at nil consideration after attaining three years performance criteria, set by the remuneration committee.
The size of the Vodafone has no doubt increased by the Acquisition of Air Touch and Mannesmann, but this acquisition didn't benefit any Vodafone shareholder. Vodafone increased its size by $184 billion but because of acquisitions and mergers it destroyed almost $105 billion wealth of an investors (Andrew, 2002). So it is correctly said "Company had vastly overpaid for the many acquisitions it had made in prior years, many with inflated stock" (PR Newswire, 2002). There were two occasions where company awarded special bonus to executives. Firstly when company merged with the Air Touch in 1999 and secondly when company acquired Mannesmann AG in 2000. Company policy does not allow for the payment of special bonuses to executives but these bonuses are paid, on the other hand it paid for acquisitions, which actually reduce the value of shareholders money (Vodafone Annual Report, 2000).
After taking above maintained agency problem into consideration, the main focus of Vodafone's is on the interest of executive and managers simultaneously with the interest of shareholders. For this purpose, company having a policy where they offer compensation to executives in form of stock option on the basis of achieving performance target which basically improve the shareholder value. "Share Ownership guidelines require ownership levels of four and three times salary respectively for the Chief Executive and other executive directors" (Vodafone Group Plc, 2001). Moreover, out of total remuneration, 80% are performance based remuneration. The above mention issue explains that the shareholders always in benefit with the performance based remuneration. To claim more remuneration, the executives would have to increase the performance. But, the main thing is that which performance we have to consider. Either simple performance or risk based performance. Performance can be increase by using different methods. To increase the performance, low cost debt is the simple solution. Also, the risk of the company increases with the increase in leverage. Moreover, as higher the debt the lower will be the equity of the company.
In 2000 and 2001 there was no indebtedness in the Vodafone because of mergers and acquisitions increased the value of equity capital. Vodafone's 31 March 2001 balance sheet shows net debt at 5.4% of the Group market capitalization (Vodafone Group Plc, 2001). Generally when a new CEO's join the company, the first thing a CEO does is to write off all the assets, to take of future profits. But, in case of Vodafone, there was a case of performance based remuneration, so intentionally the CEO not writing off its company's assets as because writing off assets would reduce the future profits and CEO's are paid on performance based remuneration. But this give a questions in shareholders eyes that the company might be overvalued. The reason of overvalued is the assets might not be worth enough that what they are showing in the balance sheet. Moreover, in the year 2000 and 2001 Vodafone Group amortised £1.72 and £11.9 billion of goodwill respectively. This amorisation amount is all part of the goodwill amount which has been created at the time of the merger of Air Touch. At the time Air Touch merger £41 billion of goodwill has been created. However, amortization of goodwill results in the reduction of assets of the company which contrary means reduction in owner's equity.
Due to write down of assets i.e. goodwill there is decrease in assets and with an increase in a liability, will definitely reduce the value of shareholders money, in general reduce owner's equity. Same thing was there in the Vodafone case. Valuation purpose also affects the value of the company. But, the actual valuation of the company would be reduced by the write down off assets and also because of heavy indebtedness. In the case of Vodafone, the heavy indebtedness can't be measure but yes, write off of assets i.e. write off of goodwill would definitely affect the valuation of the company. This will not only affect the valuation of the company but it also gives an idea that the company over paid for the acquisition. And these all give rise in all the agency problems as because executives and managers are highly rewarded at the time of these deals.
