Executive Remuneration

From Tuesday’s Financial Review:

The Australian Institute of Company Directors acknowledged last week that there have been mistakes made by company boards in setting executive remuneration. As feeble as this admission is, it is the only one shareholders are likely to see from any company board or associated body.

Notwithstanding these failures, the Institute maintains it is the board, not shareholders or government, where the responsibility for remuneration setting should continue to reside. This mirrors reports in this paper yesterday disclosing board member disquiet about re-regulating company activities.

The Institute believes that boards will improve their performance in remuneration matters. It even issued a set of guidelines to assist. But if the AICD thinks that its suggestions will help companies lift their game, it has more faith and hope than is deserved.

One AICD suggestion is that companies establish a remuneration committee of the board comprised entirely of non-executive members. It also recommended against having executives involved in setting their own remuneration. If boards allow chief executives to participate in board determinations about their remuneration, directors need more than AICDs help. But we know the first recommendation is not favoured by many companies. The chief executive of Leighton Holdings Limited, Wal King, has been a diligent member of the remuneration committee, having attended every meeting for three years. And the former executive chairman of Macquarie Group, David Clarke, was a member of its remuneration committee. Executives might absent themselves from meetings when their pay is considered, but their shadows would remain.

Another recommendation is that boards stress-test proposed remuneration contracts to see whether they are suitable for scenarios the company might face. Had this been followed, it is arguable that ever-higher executive salaries would never have happened. Testing would have shown that company profits were mostly due to cheap debt and strong economic growth – over which executives had no control – and that these profits were unstable. A lack of questioning led to many obscene payments, including the $49 million to Macquarie Banks retiring chief executive, Allan Moss. Shortly after his leaving, Macquaries share price started its precipitate fall. Had Qantas some years ago tested its remuneration policy it would not have agreed to multi-million dollar payments to executives merely because Qantas profited handsomely from government aviation policies and the liquidation of its main competitor, Ansett.

The guideline that boards avoid contracts which promote excessive risk-taking or short-termism is another obvious proposition. But it is one which many large companies, including major banks, ignore. In nine of Australias top ten listed companies – a search of News Corporations statutory reports was unsuccessful – short-term incentives for chief executives never fall below 30 per cent of total expected remuneration package. And in accord with the preference of executives, short-term incentives were much larger than long-term incentives. For the Westfield Group, nearly all recent incentive payments for its chief executive, Frank Lowy, were based on short-term considerations. Packages emphasising multi-million dollar short-term incentives help explain why only one chief executive from Australias 12 largest companies, Frank OHalloran of QBE, can claim a positive total shareholder return for the last year and the last three years. Now that the good times are over, shareholders are left with the losses while executives keep their short-term incentives.

Then there are issues not canvassed by the AICD. The Institute recommends that boards seek professional advice when setting remuneration. But it failed to warn about the conflict of interest which arises when the same remuneration consultants advise the board and its chief executive. The guidelines do not help boards to cope with the in-club pressures about pay exerted by chief executives and they do not canvass the disadvantages of using options in packages.

The AICD argues that remuneration matters be unregulated. But we know that high executive salaries are eventually reflected in ever-growing board member remuneration. This is another reason why company directors should not have unfettered rights to set executive remuneration. It is another reason for careful government intervention.

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