The Productivity Commission was asked to do a report on executive remuneration and has produced an excellent effort. You may disagree with its recommendations but as a guide to what has gone on Australian boardrooms over the past 20 years, it is very good. Every share owner in the country should read it.
The reason is that it’s not executives that come out of the report badly, it’s directors. The report is a serious indictment of Australia’s company directors. The story the PC tells is of cosy, complacent company directors who have been gulled by executives and American-style pay schemes into massively increasing the remuneration of executives for, apparently, minimal improvement in company performance.
In short, the PC has posed some serious questions of Australia’s boards, and they don’t appear to have any answers.
The issue the PC spends a lot of time coming to grips with is trying to explain why executive remuneration has exploded in the past two decades. It decided that the key influences were:
- Australian companies have got bigger and more globalised and so has the labour market for executives
- The move to incentive pay, which accounts for pretty much all the growth in executive remuneration at large companies
- Boards have been too weak, conflicted and unskilled to properly oversee incentive pay.
The PC rejected the claim, which has been pushed by the private sector and some conservative commentators, that greater disclosure requirements have encouraged higher remuneration. It found no evidence to support it, only evidence that it played a role in adjusting relative remuneration between some executives. In fact, Australian evidence seems to suggest the rate of increase slowed slightly after the introduction of greater disclosure requirements.
The PC is also of the view that the US has inspired unhealthy trends in remuneration, even if Australia is a long way behind compared to the Americans, or for that matter the UK and some European countries. We imported those trends directly through the now well-established Australian tradition of hiring US executives who cost the earth but leave behind only trashed share prices, damaged corporate brands and angry shareholders.
The commission’s greatest concerns appear to be about boards — in particular, the tendency of directors to operate like a club rather than serve the interests of shareholders. Company directors, the PC found, tend to be old, male, already have or have had other directorships and are entrenched in directorships regardless of performance. That’s why the PC wants to see greater diversity among directors (including women, whose numbers remain scandalously low).
It’s also clear that they have simply not handled the move to incentive-based remuneration well. While there have been improvements as boards have become more familiar with incentive pay, boards tended to set performance hurdles that were too easily met, were too short-term or even simply didn’t work, meaning executives were generously paid despite poor performance.
In short, directors of Australia’s biggest companies have lacked the independence and willingness to do their jobs properly on remuneration, and weren’t quite sure how to do it even if they wanted to.
Not that that discouraged directors from remunerating themselves better. A survey earlier this year showed directors’ fees at the top 50 companies had increased by 130% over the past decade. That’s faster than the growth in CEO pay over the same period.
You can see why the PC thinks there’s a “club” approach to remuneration among boards and management.
The growth of “remuneration consultants” — a profession ideally suited for Douglas Adams’s Golgafrincham “B” Ark — appears if anything to have exacerbated the problem rather than improving it. While some consultants work only with boards, others are heavily conflicted because of links with management, and in some cases rely on management for other work, making their advice hopelessly self-interested.
The commission’s draft recommendations, then, are primarily targeted at fixing the problem of poor company director performance, giving shareholders more power and requiring greater transparency, less conflicts and greater independence so that directors start doing the job they’re supposed to be doing.
Criticism of the PC — and Bob Brown yesterday suggested people should be disgusted at the report — confuses outrage over high payments with a constructive analysis of the problem. The PC has identified board failure as they key problem, and has recommended ways to address that. Calls for caps on remuneration — which would never work anyway — are a direct interference in private property rights. If shareholders want to pay CEOs tens of millions, that’s their problem. The issue is whether shareholders have the tools to make sure boards do their jobs properly — and clearly the PC thinks they don’t.
If the community still has a problem with high levels of executive remuneration — and that may be justified — then the best means to address that is through taxation, not through arbitrary interference in the operations of companies.
I knew you were one of us really Bernard. I’ve quite happy with Paul when he gave us imputation credits and even Peter managed to remove tax from some of the right people (though a bit generous to billionaire’s who wanted to set up the odd love child with a million dollars compounding for 60 years….) but those company directors who enjoy the freebies because of the gifts they make of shareholder’s money and even get gongs for it can’t even arrange remuneration rationally. It’s not as though it hasn’t been pointed out for the last few decades. If you want the best bureaucrat or software engineer in the world by all means pay him a few million a year if you genuinely think that’s what your company needs but if you want the great all-purpose CEO or CEO in waiting at least make it possible for him to lose out if the shareholders do badly over the medium to long term. If he gets $$150 million for his five year tenure in which the company grows from market cap $1 billion to $10 billion without disproportionate increase in risk and he doesn’t take it all unless the gain proves durable, that’s fine by me. But….
And BTW, that 25 per cent vote against remuneration two years running is not a good call because it runs too obviously into the answer that 75 per cent have voted in favour. So, what about 25 per cent the first year to put the directors on notice and then 50 per cent the following year. Or, better perhaps, require the directors to get a 60 per cent majority in the second year to get the package up….
The emphasis in executive pay needs to shift from incentive to performance. What is most appalling about executive pay in recent times is that they receive their pay, bonuses and shares etc even where the company is heading towards bankruptcy. If there were higher and tighter perfomance benchmarks on receiving anything other than pay in such a company, that would be a start. If the company is performing poorly, shareholders need to be empowered to place restraints on executive pay by holding it at its current level, or reducing it by the same percentages being asked of employees.
There is no doubt an old boys club among CEOs and board directors and lots of mutual back scratching. But there is also supposed to be something called business ethics, corporate governance and corporate responsibility. Diversifying the membership of boards may help. Federal Government legislation empowering share holders may help. In the end what is required are business executives with a conscience. Is that possible?
The notion that remuneration caps are a direct interference in property rights would be fine, but for four issues.
Firstly, public companies are not islands entire unto themselves. Their very existence is dependent on a fair and open society, with infrastructure, services and a market provided by the community, which also generally has a considereable stake in their success across many dimensions. The community therfore has a stake beyond the “property” rights of shareholders.
Secondly most shareholders have no direct control over the companies they own shares in. It’s their property, but they own so little of it that they are powerless to have any influence. Usually it is only a few large institutions or barons who can actually control the companies. The small sharehoders are invariably disenfranchised by the large.
Thirdly in the case of some of the companies such as banks, the automotive industry, big carbon and big mining they are underwritten by the tax payer as has been well demonstrated by the GFF and the corruption of the CPRS. I would say this gives the taxpayer some rights in regard to what their leaders get paid.
Finally the shareholders of Public companies have their ownership of the public companies with very limited liability. They have no limits on the upside, but the worst that can happen on the down side is they lose their capital. No one takes the shareholder’s house or car if the company becomes liable for damages that exceed the companies capacity to pay. This is ownership with all care and no responsibility.
I personally “own” a lot of shares in various companies. I don’t feel I “own” any part of the companies themselves. What I do believe I have a right to is a dividend and the right to sell the shares if someone wants to buy them.
We have “salary caps” for footballers, pensioners and the low paid. I would feel quite comfortable if we had salary caps for those men of genius who run our companies.
Of course, company directors should be responsible for the performance of CEO’s performance and pay, but where are the new breed going to come from? How will they get elected? Whose going to propose them? When I here some plausible answers to these questions I might have some faith in the PC’s report.
Basically the PC’s answer is as it always is: Leave it to the market. We knew this would be the answer they would give before they ever published their report. I can’t believe that it took them four hundred pages to say it!
Criteria for success of a corporation is not directly correlated to share value over the short or medium term. So this is no measure of a CEO or similar success. This is demonstrated by the simple thought experiment of slashing costs (critical plant and HR) to massively increase profit short term by simply failing to do maintenance, R&D etc etc. That is short cut the real costs of doing good business.
Secondly virtually all corporations succeed or not within the political economic context of the social fabric and civil society guaranteed by govt and taxpayer. Not the other way round. So company profits and shareholder money is underwritten by that framework. They ought to be grateful and tolerate a reasonable level of govt regulation/intervention including on executive payrates. Because their viability depends on govt and civil society. That’s the lesson in spades of the GFC. That’s also why Joe Hockey is wrong wrong wrong with his superficial argument that it’s up to shareholders alone to decide what to do with ‘their’ money.
Thirdly, and this is the flaw in BK’s piece above and the PC no doubt: If there is a director’s club lacking merit, guess what the price of protection of that board will be – a big fat green light to excessive exec pay so these latter also don’t blow the whistle on lazy incompetence. In other words the exec joins the club and maintains the barriers. And gets paid danger money to be the public face and protect the board in a mutual buttressing exercise. It seems apart from pay rates the distinction between board and exec is one without a difference, and why the PC have their head up their *rse (again) like so many other policy areas, being so market faith based.
When are they going to acknowledge the market is a political economic invention?
I didn’t see Roger’s piece before mine but notice the echo. Also I ought to have added at end of first paragraph the big short term profit allows significant dividends to be paid out appeasing big institutional shareholders run by people on their own short termism culture, and at the cost of firm sustainability and long term growth. Inother words cannabilising the firm rather than harvesting the bounty.