In a tactic reminiscent of The Hollowmen or Yes, Minister, the executive pay debate continues to lurch forward with little urgency, the Federal Government asking APRA to release a draft of a principles-based framework on executive pay. The Financial Review this morning reported that the framework “is largely expected to track the work being undertaken by the Financial Stability Forum… which will also establish a global set of principles on executive pay by April.”
Just in case you didn’t catch that, the Australian government’s insurance and banking regulator is to prepare a draft of a framework based on a bunch of yet-to-be-specified non-binding principles from another country — fear not executives, your multi-million dollar short-term bonuses are far safer than your investors’ capital.
The limp response of the Labor Government to corporate governance reform contrasts with the heavy rhetoric outlined by Rudd and corporate governance Minister, Nick Sherry, when they took office in 2007. Ordinary workers must look on with a sense of bemusement as their Labor government suggests that low paid workers sacrifice pay rises to save their jobs, while incompetent executives not only receive burgeoning remuneration, but also generous tax treatment of equity incentives and termination payments up to seven times total remuneration in the event that their performance requires their removal.
Leaving aside the obvious problem that a non-binding set of principles of is completely useless and will be utterly ignored, is the fact that solving the executive pay problem is actually an easy task. The most significant dilemma with executive remuneration is that there is no functioning free market for executive talent. CEOs are hired in a clandestine manner by highly paid search firms, and their pay structure is determined by remuneration consultants (percipiently dubbed, Ratchet, Ratchet & Bingo by Warren Buffett) paid by the firm. The company’s remuneration is then finalised by friendly directors (and sometimes, even the CEO himself who will be a member of the Remuneration Committee). As a result, executive pay generally bears little or no resemblance to the performance or ability of the executive.
This inevitably leads to complicated, and generous remuneration structures.
As Crikey noted recently, 17 of the highest paid executives in the country earned between $22 million and $86.6 million in the past three years, despite their companies generally underperforming the benchmark. Phil Green of Babcock & Brown received more than $50 million despite his company losing more than 99% of its value and remaining alive courtesy of the good graces of its bankers.
APRA’s mooted principles on executive pay merely seek to temper remuneration based on the capital required by the business. This may be possible (albeit unwieldy) for banks, but of little relevance for established industrial or non-capital intensive, information-based businesses. For example, the draft remuneration guidelines would do little to temper the remuneration received by Rupert Murdoch, who was paid $86.6 million in the past three years. During that time, NewsCorp shares have fallen by 55%.
If the Federal Government really wanted to curb executive pay and properly align executives with “working families”, the solution is simple. Allow executives to receive only fixed cash remuneration which must be approved by shareholders. In lieu of bonuses, executives may be able to receive a full-recourse loan (from the company or a third party) to purchase ordinary shares which are subject to a minimum 10-year holding lock.
If the company’s share price increases, executives are able to benefit in-line with shareholders. If the share price falls, executives not only lose their bonuses, but may also lose the security which they provided for the loan (just like shareholders would). While the solution isn’t perfect (such a the loan would effectively be a margin loan), the quantum of such a loan (a few million per year) would not likely be high enough to warrant short-targeting of a stock.
Forget about risk adjusting capital — to align executives with shareholders, the executives need to face the same downside as shareholders. That doesn’t happen with cash-based short term bonuses, or performance rights with EPS hurdles.
But Kevin Rudd and Nick Sherry don’t actually want to curb executive pay. They just want to look like they are doing something. Expect to see a lot more studies, draft reports and principles, none of which will have any bearing on executive remuneration.