HomeBusiness DigestBrett Chulu: Candid questions on director loans trend

Brett Chulu: Candid questions on director loans trend

ORDINARILY, giving loans to directors of a company should not be a messy affair. However, our obtaining economic and corporate governance circumstances raise uncomfortable questions.

The issue of director loans is multi-layered, launching us deep into International Accounting Standards (IAS), ethics, taxation, financial and remuneration territories.  
Perhaps, at the outset we need to ask a simple question: Is a loan to a director a salary? We know how Tendai Biti hit the ground running following his appointment as the Minister of Finance, introducing a raft of bold and decisive financial reforms. One such decision effectively rules that any portion of a loan given to an employee at below commercial interest rates becomes part of gross remuneration and thus is taxable in the hands of the employee.
Interestingly, a recent circular by Innscor is inviting shareholders to approve a proposal to empower the board of directors to give or guarantee loans to executive directors up to the equivalent of a director’s annual salary. What is interesting is mentioning the remuneration committee’s involvement in deciding the amounts (and possibly the terms too) of such loans. Many companies, apparently, are jumping onto the bandwagon. Could it be that by making reference to the remuneration committee, companies are innately aware that part of the loan to an executive director constitutes remuneration?
The current loan trend, viewed against the backdrop of poor economic performance requires us to lower our analytic anchors little deeper, asking very candid questions. Isn’t what democracy entails?
First, if loans to executive directors are given at concessionary rates, is there no possibility that this will promote arbitrage in the financial markets. We are now wading in ethical waters.
A director earning US$5 000 per month can be given a loan of up US$60 000 by their organisation, according to the proposals being brought for a shareholder say-so. Presently, the RBZ is not active in the financial markets, effectively leaving the country without a benchmark on the cost of money (interest rates). Those with excess cash are dictating how much they want for their money. Currently, we are talking 24-36% interest per annum. What can stop an executive director who gets a loan of US$60 000 at 10% per annum to resell this “loan” at 36% per annum, getting a return of 26% per annum, returns hardly assured these days on the Zimbabwe Stock Exchange, let alone company return on investments (ROI)? Is an on-selling of cheaply obtained loans not a form of arbitrage? Who cares what an executive does with their loan, organisations may wash their hands, but, perhaps not their conscience. 
Second, executive director loans are a subtle, perfectly legal and smart way of effecting above-inflation pay awards. In theory, directors on-selling their loans will get a before-tax equivalent of US$1 300 per month. That is an equivalent pay rise of 26%! Even if they do not on-sell the 26% pay increase still holds from the taxman’s standpoint. With an inflation rate under 5% per annum, that equivalent pay increase is 4,2 times ahead of nominal inflation, giving an equivalent real increment of about 21%. Is this an increase via the backdoor?
Organised labour is daring executives to disclose their salary increments to justify their impassioned plea, entreating workers not to demand wage adjustments above inflation.  Organisations could, however, strongly argue that loans to directors are not part of a director’s salary.
Believe me, this is not a careless statement. IAS24 (AC126), an international accounting standard dealing with related party transactions has loopholes that can bolster a corporate’s defence that loans are not part of remuneration. The idea behind related party disclosure is that transactions involving related parties, for the most part, are done under preferential terms (below market norms), potentially making financial reports not directly comparable to those of  companies without related parties. According to IAS24 (AC126).09 key management staff falls under related parties. 
Fittingly, companies are obliged by the standard to publicly disclose two things about key management staff: their remuneration and company facilitated loans. IAS24 (AC126) instructs companies to categorise the disclosure of key management remuneration into four groups namely: short-term employment benefits, post-employment benefits, other long-term benefits and share-based incentives. Clearly, director loans are not part of remuneration according to IAS24, handing companies the perfect weapon to silence anyone daring to link director loans to remuneration.
As an aside, I wonder why fewer than five banks disclosed the remuneration of key management staff in the interims published in the media given that IAS24 provides no room for cherry-picking. Is this a brazen calculation to hide some shenanigans or just an act of innocent omission?
Third, is this shift towards director loans, an indication that share options are losing their adhesive qualities?  Stocks generally are not performing well on the ZSE. Add too, the spectre of sustained depressed share performance. Share options could be becoming the proverbial first wife facing painful loss of attention to the husband’s newest fixation. A share option is an agreement giving a qualifying employee the right to buy an agreed quantity of shares at a fixed price at a future date. Between May 27  and June 2  2008, R Strydom, a director with Exarro Resources, a South African listed company exercised options at R17,96 per share and immediately sold off for R149,50 per share to make a profit of 732%!   That’s how potentially sweet share options can be.
To sweeten the deal, in the majority of cases provisions are made for employees to delay cashing their shares for ten years, hoping the share value will climb further and thus consider waiting patiently for say eight years for the ultimate boon. This is precisely what a company might want, having their prized executives tied as long as possible.  Realistically, our subdued economic outlook means that many executives are not so confident that after three years (common minimum waiting period) share prices would have soared high enough to deliver the honey.
This could be one reason why organisations are resorting to loans as a way of retaining key executives, hoping that by offering their prized talent to repay over say three years, they might be persuaded to delay serving divorce papers. The flip side, however, could be that directors now want to exercise options awarded a few years ago, but just do not have the cash to do so. By giving loans, organisations could be acting as a knight in shining armour rescuing cash-strapped executives desperately wanting to cash their share options.
Fourth, are we seeing a trend whereby long-term lending, at concessionary rates for that matter, is going to individuals rather than industry and commerce badly in need of rightly priced long-term loans to give the economy a jump start? Is that ethical?
Last, since IAS24 obliges an organisation to disclose the transactions of related parties without “salarising” concessionary director loans; are profits being currently reported overstated? Strategic HR has always been clear that concessionary loans to employees must be “salarised”.
Is HR’s common sense a rebuke to the accounting profession’s apparent reticence on this front?

 

Share your views on this matter at brettchulu@consultant.com

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