The boardroom challenge Executive remuneration

Tuesday, 01 May 2001


    Executive remuneration is the hot button issue at the moment and boards are under pressure for sanctioning payouts that are often not reflective of the company’s performance. As John Arbouw reports, it is an issue that will challenge all boards and all directors.

    Exceptions always prove the rule and in the executive remuneration debate the perceived remuneration excesses in a few high-profile cases ensure that the issue receives constant media and government attention. A balanced debate of what we should pay managers and directors, the method by which that remuneration is determined, its relationship to global practice and competition for executive talent is often lost or obscured. Yet the latest Executive Remuneration Top500 2001 report from Remuneration Planning Corporation Pty Ltd says that the "remuneration of directors and executives when compared to previous reports has been reasonably subdued". The report says the results are in line with Australia's economic performance and the volatility in the markets thus creating an environment that is not "conducive to the negotiation of remuneration increases". RPC has also noted a general trend towards the provision of long-term incentives as well as linking remuneration to incentives or "at risk" remuneration. "As performance has been subdued incentive payments would not have been high and this may have held down the incidence of increases in overall remuneration," the report says.

    While market conditions have subdued executive pay rises in some instances, managing directors and CEOs of larger corporations have managed to do better than the general trend. According to the report, the reason for this is: -larger corporations MD/CEOs are an international commodity and are subject to international shortage; and -because they are an international commodity their remuneration would have been affected by the decrease in the value of the Australian dollar. If Australian executive remuneration increases have been subdued because of market conditions, American executive pay is also on the way down although it has further to fall. According to the April 16 edition of Business Week, while the CEO gravy train may be slowing down, it hasn't jumped the rails. In 2000, despite weakening returns, US company chieftains bagged on average a princely $13.1 million. Cash compensation for CEOs at 365 of the largest US companies increased 18 percent in 2000, while total pay increased 6.3 percent. "While shareholders got hammered, many compensation committees scrambled to cushion their chief executives from feeling any real pain, granting massive blocks of new stock options in some cases and in others forgiving corporate loans," says Business Week. However, the magazine noted that the increase in total compensation was the smallest in five years, and 2000 was the second consecutive year of slower executive pay growth.

    The big executive remuneration issue both here and in the US will be the inevitable push by chief executives to extract themselves from their options that are now underwater thanks to the downturn. "In a booming economy, options were the incentive of choice because gains could be astronomical, and they belonged to the executive whether he stayed at the company or left. Now there's a new favourite: restricted shares, which typically vest after several years provided the executive remains employed at the company, and are safer than options because they always retain at least some value," says Business Week. The issue of executive remuneration is of course a vital plank in any company's corporate governance structure. The ALP warned companies when releasing its corporate governance policy last month that if it wins office it will take a hard look at disclosure requirements for executive remuneration. The ALP also believes that issuing of options is a cost to shareholders and that options granted to executives should be valued in the accounts of the company.

    The ALP wants the Australian Accounting Standards Board to finalise an accounting standard so that there is certainty in the valuation of options and so that the Australian Securities and Investments Commission can enforce the existing provisions of the Corporations Law. (AICD issued a media release on this issue that can be viewed at RPC intends to look at the area of long term incentives including shares and options in a separate report due for release in July. Traditionally, options have been valued using the Black-Scholes method. However, it is widely accepted that this method is insufficient for valuing options particularly for accounts' purposes when performance hurdles are in place. A new method for valuing options that improves on the Black-Scholes method has been devised by two former employees of Towers Perrin and Tillinghaust-Towers Perrin (Paul Carrett and Bernard Wong). If this proves to be the case, companies will have little excuse for not bringing options into the accounts. It should prove interesting.

    But corporate governance and executive remuneration is more than valuing options. According to US governance expert Bob Monks, notwithstanding the clear statutory mandate that the directors select and can and, in recent times occasionally do, remove the CEO, boards have universally proved incapable of controlling executive compensation. In a recent essay on the subject Monks says executive autocratic power (in determining executive remuneration) may well be the "smoking gun" that offends political and social sensitivities. "When business and stock prices turn down, CEO pay will be the target of public rage and the excuse for government involvement," he says. In Australia, executive remuneration is largely the function of remuneration committees comprising the non-executive chairman and non-executive directors. The accepted process is the development of a remuneration strategy, designing the package, implementation and disclosure. According to Hay Management Consultants although providing too much detail could be seen as commercially unwise (and might go beyond what most shareholders would want to know), there is a strong case for providing information about

    • remuneration comparators and the targeted level of relative competitiveness including how this relates to company or personal performance;

    • the rationale behind the performance measures chosen for annual bonus and long-term incentive schemes;

    • the package mix which should go beyond a list.

    The challenges for board leadership in the executive remuneration debate are obvious. Government and stock markets around the world are recognising the need for stronger laws to protect the interests of shareholders and stakeholders. The principle of voluntary codes of practice is at risk. Shareholders are becoming more active, including institutional shareholders and there is undoubted pressure for them to be more pro-active in their investment decisions. Shareholder value has also taken a hammering. There is a perception that many business executives have reduced product quality and customer service and engaged in all manner of techniques to re-engineer their companies simply to increase profits to increase their take home pay. This perception may be unfair but it is at the heart of the outrage that occurs whenever a high-profile company hits the wall and executives walk out with large packages while shareholders and suppliers are left to pick up the pieces. The latest craze in share buy-backs may, in some instances, be good for the smaller shareholders but it also manipulates the earnings per share ratio and therefore the company's share price that is often an executive remuneration performance hurdle.

    Similarly, the spate of mergers and acquisitions over the past 18 months has been unprecedented. Far too many of these M & A's have destroyed shareholder value rather than added to it. The short-term effect however, is a run on the share price. Executive remuneration, in the Australian context will always be an issue. The politics of envy is an accepted tradition. The challenge for boards is to ensure that transparency and appropriate disclosure will minimise the risks of adverse reaction from shareholders, stakeholders, government or the public.


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