The bestselling book, Moneyball, by Michael Lewis, should be essential reading for company directors across Australia. Moneyball chronicles the amazing achievements of the Oakland Athletics baseball team in the United States.
Despite paying its players less than almost every other team, Oakland won more regular season games than any other in the early 2000s. Moneyball asserts that Oakland achieved its remarkable success by changing how it statistically measured success.
Oakland’s strategies, which were adopted by general manager, Billy Beane, were based on the writings of a little-known author called Bill James (who now works for the Boston Red Sox).
James determined that many statistics grossly overvalued certain players, while underrating others. Taking James’ hypothesis one step further, Lewis noted:
If gross miscalculations of a person’s value could occur on the baseball field, before a live audience of thirty thousand, and a television audience of millions more, what did that say about the measurement of performance in other lines of work?… Bad as they may have been, the statistics used to evaluate baseball players were probably far more accurate than anything used to measure the value of people who didn’t play baseball for a living.
Lewis’ analogy works well on the group of people who are among the highest paid in our society–public company chief executives. While no one likes to admit it, by and large, CEO pay is determined by the market capitalization and total profit of the employer (and unfortunately, only to a lesser degree, profitability). The problem is, a company’s market capitalization or total profit has little or no relationship to the value being added by the executive.
In today’s AFR, Eric Johnston says that CBA boss, Ralph Norris, is among “the lowest paid of the major lenders”. Johnston noted that:
Mr Norris’ pay cheque represents just 0.15 per cent of CBA’s latest annual profit of $4.47 billion. [Westpac boss, David] Morgan’s represents 0.27 per cent of Westpac’s $3.07 billion profit in 2006. But both were eclipsed by Macquarie Bank chief executive Allan Moss whose salary of $33.5 million represents 2.2% of the bank’s $1.55 billion profit last year.
Using total profit earned as a yardstick for paying an executive is a bizarre concept, upon which the only reasonable rationale is laziness. Under Johnston’s thinking, the CEO of $40 billion Rio Tinto should be entitled to earn eight times more than the CEO of $5 billion Oxiana – even though Oxiana boss, Owen Hegerty, has returned shareholders 58% in the past five years (RIO has returned around 25% over five years).
An even better example is the recent appointment of the very successful St George boss, Gail Kelly, to become CEO of Westpac. As noted by the AFR, Kelly’s “total annual remuneration will more than double to a maximum $8.7 million compared with the $4.3 million she was paid by St George last year.”
The most feasible explanation for Kelly’s huge pay rise is because Westpac is a larger company than St.George, it has to pay its CEO more. That is despite the fact that Kelly’s job probably won’t be any more challenging (if anything, CEOs of larger companies have greater access to top notch bankers, lawyers and consultants, who would make their job easier, rather than more difficult) and Kelly has yet to actually prove to be of value to Westpac.
More often than not, CEO remuneration is not determined by the value added or the performance of the executive, but rather market capitalization and total profit. Shareholders would be hoping that one day, directors and the media will start to think like the Oakland Athletics.
Until then, lackluster CEOs can relax, for theirs is one of the few roles where ability and results comes second to a factor totally detached from their performance.