Tomato Bank

7/28/2019 Tomato Bank

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Tomato bank2 (a) Criticisms of remuneration committeeThe remuneration committee has demonstrated failures of duty in several areas.

There is evidence of a lack of independence in the roles of the non-executive directors (NEDs) who comprise the committee.

One of the main purposes of NEDs is to bring independent perspectives within the committee structure and shareholders have

the right to expect NEDs to not be infl uenced by executive pressure in decision-making (such as from the fi nance directors).

Two of the NEDs on the remuneration committee were former colleagues of Mr Woof, creating a further confl ict. The effect of

this lack of independence was a factor in the creation of Mr Woofs unbalanced package. That, in turn, increased agency costs

and made the agency problem worse.

There was a clear breach of good practice with the remuneration committee receiving and acting on the letter from Mr Woof

and agreeing to the design of the remuneration package in such a hasty manner. Remuneration committees should not receive

input from the executive structure and certainly not from directors or prospective directors lobbying for their own rewards.

Mr Woof was presumptuous and arrogant in sending the letter but the committee was naive and irresponsible in receiving and

acting upon it.

There is evidence that the remuneration was influenced by the hype surrounding the supposed favorable appointment in

gaining the services of Mr Woof. In this regard it lacked objectivity. Whilst it was the remuneration committees role to agree an

attractive package that reflected Mr Woofs market value, the committee was seemingly coerced by the finance director and

others and this is an abdication of their non-executive responsibility.

The committee failed to build in adequate performance related components into Mr Woofs package. Such was the euphoria

in appointing Mr Woof that they were influenced by a clearly excitable finance director who was so keen to get Mr Woofs

signature that he counselled against exercising proper judgement in this balance of benefits. Not only should the remuneration

committee have not allowed representations from the FD, it should also have given a great deal more thought to the balance

of benefits so that bonuses were better aligned to shareholder interests.

The committee failed to make adequate pension and resignation arrangements that represented value for the shareholders

of Tomato Bank as well as for Mr Woof. Whilst pension arrangements are within the remit of the remuneration committee and

a matter for consideration upon the appointment of a new chief executive, shareholder value would be better served if it was

linked to the time served in the company and also if the overall contribution could be reconsidered were the CEO to be removed

by shareholders for failure such as was the case at Tomato Bank.

(b) Components of a rewards packageThe components of a typical executive reward package include basic salary, which is paid regardless of performance; short and

long-term bonuses and incentive plans which are payable based on pre-agreed performance targets being met; share schemes,

which may be linked to other bonus schemes and provide options to the executive to purchase predetermined numbers of

shares at a given favourable price; pension and termination benefi ts including a pre-agreed pension value after an agreed

number of years service and any golden parachute benefits when leaving; plus any number of other benefits in kind such as

cars, health insurance, use of company property, etc.

Balanced package is needed for the following reasons


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The overall purpose of a well-designed rewards package is to achieve a reduction (minimisation) of agency costs. These are

the costs the principals incur in monitoring the actions of agents acting on their behalf. The main way of doing this is to ensure

that executive reward packages are aligned with the interests of principals (shareholders) so that directors are rewarded for

meeting targets that further the interests of shareholders. A reward package that only rewards accomplishments in line with

shareholder value substantially decreases agency costs and when a shareholder might own shares in many companies, such

a self-policing agency mechanism is clearly of benefi t. Typically, such reward packages involve a bonus element based on

specific financial targets in line with enhanced company (and hence shareholder) value.

Although Mr Woof came to Tomato Bank with a very good track record, past performance is no guarantee of future success.

Accordingly, Mr Woofs reward package should have been subject to the same detailed design as with any other executive

package. In hindsight, a pension value linked to performance and sensitive to the manner of leaving would have been a

worthwhile matter for discussion and also the split between basic and incentive components. Although ambitious to design,

it would have been helpful if the reward package could have been made reviewable by the remuneration committee so that a

discount for risk could be introduced if, for example, the internal audit function were to signal a high level of exposure to an

unreliable source of funding. As it stands, the worst that can happen to him is that he survives just two years in office, during

which time he need not worry about the effects of excessive risk on the future of the company, as he has a generous pension

to receive thereafter.

(c) Ethical case for repaying part of pensionMr Woof was the beneficiary of a poor appointments process and his benefits package was designed in haste and with some

incompetence. He traded freely on his reputation as a good banker and probably inflated his market value as a result. He

then clearly failed in his role as a responsible steward of shareholders investments and in his fiduciary duty to investors. In 15

exposing the bank to financing risks that ultimately created issues with the banks economic stability, it was his strategies that

were to blame for the crisis created. The fact that he is receiving such a generous pension is because of his own lobbying and

his own assurance of good performance places an obligation on him to accept responsibility for the approach he made to the

remuneration committee five years earlier.

The debate is partly about legal entitlement and ethical responsibility. Although he is legally entitled to the full value of the

pension, it is the perception of what is fair and reasonable that is at stake. It is evident that Mr Woof is being self-serving in his

dealings and in this regard is operating at a low level of Kohlbergs moral development (probably level 1 in seeking maximum

rewards and in considering only the statutory entitlement to these in his deliberations). A more developed sense of moral

reasoning would enable him to see the wider range of issues and to act in conformity with a higher sense of fairness and justice,

more akin to behaviour at Kohlbergs level 3


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lalland

3 (a) Charities and public listed companiesDifferencesFirstly, the two types of organisation are different in terms of regulation. Listed companies are subject to all the provisions of

company law plus any listing rules that apply. Listing rules, such as the need to adopt the Combined Code in the UK, impose

a number of obligations upon listed companies such as non-executive directors, committee structures, a range of reporting

requirements, etc. Charities, in contrast, must receive recognition by a countrys charity authority to operate and they then

12receive the concessions that charitable status confers. This often involves favourable tax treatment and different reporting

requirements. Because charities are not public companies they are not subject to listing rules although, depending upon the

countrys rules, they may be subject to audit and have some reporting requirements.

The second difference is in the strategic purpose of the organisation. Listed companies exist primarily to make a financial

return for their investors (shareholders). This means that they employ and incentivise people, including directors, to maximise

long-term cash flows. Value is added by the creation of shareholder wealth and this is measured in terms of profits, cash

flows, share price movements and price/earnings. For a charity, the strategic purpose is to support the charitable cause for

which the organisation was set up. It is likely to be a social or benevolent cause and funds are donated specifically to support

that cause and this expectation places a different emphasis on the purpose of governance.

Thirdly, the two are different in terms of stakeholders and societal expectations. Society typically expects a business to be

efficient in order to be profitable so that, in turn, it can create jobs, wealth and value for shareholders. Society expresses its

support for a business by participating in its resource or product markets, i.e. by supplying its inputs (including working for

it) or buying its products. A charitys social legitimacy is tied up with the charitys achievement of benevolent aims.

Stakeholders in a business often have an economic incentive to engage with the organisation whereas most stakeholders in

a charity have claims more concerned with i ts benevolent aims.

Governance arrangements

There can be a number of substantive differences between the governance structures of public companies and charities. In

a public company, a board consisting of executive and non-executive directors is accountable to the shareholders of the

company. The principals are able to hold the board accountable through AGMs (annual general meetings) and EGMs

(extraordinary general meetings) at which they can vote on resolutions and other issues to convey their collective will to the

board. In a charity, the operating board is usually accountable to a board of trustees. It is the trustees who act as the

interpreters and guarantors of the fiduciary duty of the charity (because the beneficiaries of the charity may be unable to speak

for themselves). The trustees ensure that the board is acting according to the charitys stated purposes and that all

management policy, including salaries and benefits, are consistent with those purposes.

(b) TransparencyDefine transparency

Transparency is usually defined in terms of openness and adopting a default position of information provision rather than

concealment. This means that unless there is an overwhelming reason not to disclose information of any kind (perhaps for

reasons of commercial sensitivity) then information should be disclosed or made available upon request to any interested


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stakeholder.

The case for greater transparency at HHO

Transparency is an important principle in corporate governance, including at HHO, for a number of reasons.

In general, transparency has the effect of reassuring investors that their funds are being responsibly stewarded and used for

worthwhile investments. In the case of a charity, such as HHO, without shareholders in the conventional sense, donors give

money to support the charitys stated aims and purposes. With the relief of suffering to animals being a prominent reason any

donors give to HHO, the amount of money diverted for other purposes, such as salaries, would be information of considerable

interest.

Transparency would inform and placate HHOs critics, including the journalists who are investigating it. Public commentators

like journalists are capable of causing damage to HHOs reputation and this in turn can affect donations and support for the

organisation.

There are a number of potentially damaging allegations made against Mr Hoi including the likelihood of large payments to

himself and some profligacy in the purchase of the private jet. These allegations could be rebutted if the organisation were to

make the accounts public and explain the case for the purchase of the jet. For a charity receiving money from well-meaning

individuals that care greatly about animal suffering, the allegations have the potential to do much reputational damage to the

charity.

The publication of the financial data is an inadequate expression of transparency and appears to be a poor attempt to give

the appearance of providing information whilst providing no useful detail at all. This would not meet any stakeholders

information needs and fails to address any of the concerns raised about HHO. It does not give any absolute financial figures,

for example, in terms of income and costs. Such a truncated summary actually gives the impression, to any informed observer,

of an attempt at concealment and this provides a strong reason to provide a full financial statement.

(c) Audit committee and internal controlsThere are a number of apparent internal control deficiencies, although the case does not permit definite and specific

allegations of IC deficiencies to be made or to conclude that a complete lack of governance structure exists at HHO. However,

any such organisation would benefit from having an audit committee with wide-ranging powers and responsibilities when

reviewing internal controls. With regard to the situation at HHO, the most important areas for audit committee attention are

monitoring the adequacy of internal controls, checks for compliance with relevant regulation and codes, checking for fraud

and reviewing existing IC statements for accuracy.

13 Monitoring the adequacy of internal controls involves analysing the controls already in place to establish whether they are

capable of mitigating risks. In the case of HHO, there are internal risks that the controls need to be capable of controlling.

The risk of fraud and the risk of compliance failure are relevant internal risks.

To check for compliance with relevant regulation and codes refers to HHOs compliance with its legal and other regulatory

constraints. It is likely that HHO has a number of regulatory constraints as a result of its charitable status. It may also have

voluntary codes it seeks to abide by, perhaps made public through its marketing or reporting literature, and the audit

committee could also test for compliance with these.

Checking for fraud is also within the remit of an audit committee and this would, at first glance, be a priority at HHO. There

are grounds for believing that inadequate remuneration policies exist at HHO and grounds for suspecting some financial

dishonesty. There also seems to be a lack of accountability for the behaviour and actions of Horace Hoi, especially if the


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claims about his lavish lifestyle are accurate. The misuse of donations for personal enrichment would be outside of what is

allowed under his charitable status and this could be reviewed by the audit committee.

Finally, an audit committee could play a more supervisory role if necessary, for example reviewing major expenses and

transactions for reasonableness. This might include measuring transactions against its regulatory regime and the reasonable

expectations of its trustees and donors

Documents

Tomato Bank