The Relationship between the Management Compensation and the Usage of Hedging Instruments in Croatia

Abstract

During the accounting harmonization process between the universal accounting standards of the International Accounting Standards Board and the American Financial Accounting Standards Board, the standardization of the share-based payment may be pointed out as one of the successful projects. The American Financial Accounting Standards Board accepted the European proposal on the standardization of this field regardless the discontent of the major American corporations. The novelty in the standard is the reporting requirement of the allocated employee stock option costs in the profit and loss account according to their fair value, instead of the usual reporting scheme according to their intrinsic value. The consequence of such a treatment of the employee stock options is that the reported profits have been decreased in the companies who decided to stimulate the employees and the management in this manner. The reduction in profits reported ranges between 10% and 50% of the profits reported before the introduction of the standard. Research results also indicate on a negative correlation between the level of management compensation using stock option plans and their willingness to use derivatives to hedge the company’s fair value, cash-flows and translation exposures. According to the Croatian Accounting Act, it is the Company’s obligation to compile the financial reports in line with the International Financial Reporting Standards adopted by the International Accounting Standards Board. In line with the above law, Croatian companies which securities are traded publicly or which have the obligation to compile consolidated financial reports, also have the duty to apply International Financial Reporting Standards in their full extent. This also implies they have to report in line with the IFRS 2, Share-based payment. This paper shows the effects of the application of the new accounting treatment of executive management awarding schemes, using stock option allotments, on the reported financial position and business results. Moreover, the hypothesis viability on a negative correlation between stock option compensation of the executive managers and active hedging policies will be described in this paper.