smell of good business

Excessive Executive Remuneration

There has been a lot of comment in recent times about the levels of executive remuneration particularly in relation to companies that are underperforming. 

Taking a step back, we should understand the origins of the nature of directorship and ask a good simple clean and hard question: is this in line with the original intent?

As companies grew in the 1800’s it became apparent that a different style of manager was required to look after the interest of shareholders – those people were not active managers within the company. People appointed in this role of looking after the shareholders interests became known as company directors.

Today the same remains true – directors manage on behalf of shareholders, and they must put the shareholders first, with the obvious caveats of acting ethically and legally.

Executive remuneration is a touchy issue. Should the board not have the right to determine the correct market rate for a potential candidate? Is this not within the realm of directorship and corporate governance?

Unfortunately, reason has been lost sight of in some cases. Transparency of reporting has made it more difficult for boards to negotiate downwards. There is a frankly uncomfortable scenario in which boards end up determining their own remuneration and that of the executives – and frankly the higher the earnings of the executives, the greater that substantiates a higher remuneration for directors. There has been enormous criticism of audit companies with consulting divisions working with the same firm, yet isn’t the scenario very similar? Frankly the community and government in Australia have had enough of the sensationalist headlines with no action and have had enough. And so they should.

Whilst I fundamentally believe in free market economies and ensuring decision makers are free to make the decisions they need to with delegation from an accountable board, I cannot reconcile remuneration packages that are equivalent to the full profit figures of mid sized companies. A simpler model and principle that was shared with me at a discussion last night suggested that no person will receive remuneration in excess of 30 times the most junior employee. Some will argue it should be higher or lower, but either way it is a more modest, albeit simple principle at play.

AICD, an organisation I have a great deal of respect for, have lost the opportunity to lead the issue. By refusing to criticise the practice, they are being seen to endorse it. I understand the difficulty of their position, however, falling back to a stance of more education – when clear greed is at play – is proven through history to be unsuccessful. As a result, I have no doubt legislation will be brought it much more extensive and onerous than could have been negotiated – and potentially interfering in areas outside of remuneration. Being a company director is a very difficult exercise, more red tape isn’t the answer. But perhaps by more shareholders taking an active part, they will put an effective brake on these practices.

Have I got this right or wrong? Your comments are welcomed….

5 thoughts on “Excessive Executive Remuneration

  1. I may be too cynical but I believe directors have the best interests of the shareholders at heart in the same way that Santa is keeping track of how well kids behave and the tooth fairy runs a second hand market on little kids’ teeth: its a nice idea but its a big fat myth.

    The fact of the matter, at least in the US where I am for a few years before coming back to Oz, is that directors and any level of executive above a certain level of seniority are _no a junket_. Seriously, it’s about the cash, the power, doing as little as one can do to get paid a boatload. I really don’t think that is too cynical, it just makes sense when you step inside their mind for a while.

    Shareholder value? Seriously? Think about this: can the price of a stock go up and up forever? Granted, I don’t have statistical proof of this, and some stocks (Berkshire) go up pretty much forever. But the idea of ever increasing stock value is bogus, therefore the idea of employing someone to increase stock value forever is bogus.

    Protecting the franchise, yes. Keeping a business alive and generating profit, yes. Looking for new opportunities, and trimming bad ones, yes, absolutely.

    But “shareholder value” … I think that is the myth in itself.

    I can go on about how I think the notion of listing a company is the root of this flawed logic (if the idea is or was ever about giving operational money, then why is all the “real” money made after the IPO, hmm?), but for now, I want to sign off with one positive note: the idea of a 30x (or whatever) “reality check” is excellent. Very much what I think is appropriate. Wouldn’t fly in the US where the indentured class get $5/hr so executives could get no more than $150/hr = $300k/year (seriously, my manager earns multiples of that and he’s 4 levels down from the top), but I really agree that the work done by tops of companies isn’t more than 30 (or 50 or whatever) as important.

    Though I’m sure they’d beg to differ.

  2. Great comments Andrew, and very interesting perspectives. The larger the company, the more this type of behaviour seems to go on. A good board should set the tone for corporate culture. I’ve been fortunate in that company directors I have met have for the most part been really genuinely interested in improving the business and creating strong dynamic companies that remain profitable. However I have certainly met more than a fair share of executives who meet the criteria you describe to a T.

    I also think that culture plays a big part of influencing behaviour. My brother worked for KPMG in New York for a few years before coming back to Australia, and his insights into the comparison of culture in the US vs Australia was really interesting (both in terms of positives as well as negatives), and I’d be really interested in your views on this.

    Thanks for taking the time to visit this blog and for posting your comment….

    Justin

  3. I believe that any attempt to regulate director and executive remunerations would eventually restrict company growth potential and ultimately harm the people you are trying to benefit – share holders. Each company needs to be able to determine what they are willing to pay to attract the calibre of director or executive they require.

    If you limit remuneration on some multiple of the lowest paid employee, you will get a situation where a multi-billion dollar company is paying their directors and executives a fairly average wage. This is because these large companies probably employ a junior with a wage that would not be too different to that of a small market cap company.

    When you consider the personal risk and effort a Director or Executive takes in running a large company, why would they take on a high profile/high risk role when they could just go and take a place in a less risky business, unless there is some appropriate incentive? I think the key word here is “appropriate” (as opposed to “exorbitant”).

    Of course, it is important to structure a remuneration package that shareholders support. This includes defining performance measures that determine the payouts (we’ve recently seen directors and executives being paid high remunerations when in fact the company is not performing well).

    I agree – there needs to be some form of governance and shareholder approval to help get acceptable remuneration packages. The question I have is: does the average shareholder have the information they need to define (or even just to ratify) an executive’s remuneration package? And if its not the directors, executives or shareholders – who decides?

  4. Thanks for the comment Craig, good ideas there. And it gets to the essence of the issue:
    1. Many shareholders aren’t really well placed to understand what is fair and reasonable. Sophisticated investors are, and those large sophisticated investors – share funds and superannuation funds – actually do understand this.
    2. The personal risk is very high for company directors, and getting higher.
    3. When market forces are interfered with, such as with legislation, we often get unintended consequences.

    Fundamentally we get to the issue of fairness – what is a fair return for bearing risk, what is a fair return for effort on a company in falling or growing market, what is considered fair by the shareholders of the company, and what is fair for entrepreneurial return. The market sentiment from both sides are: 1. Some executives (and in most cases it is the executives singled out for the headlines) are getting paid large returns despite poor company performance 2. The personal career and financial risk is such that a return must be very high to justify it.

    No doubt there will be plenty of comment on the issue, and it is good to see current headlines (The West Australian business section 23 May 2009) showing Wesfarmers executives choosing to cap salaries and reduce bonus payments. This is the sort of initiative that we should expect market forces to create.

    Disclosure: I am a shareholder in Wesfarmers.

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