The Productivity Commission released its final report on executive pay earlier this month, with few substantial changes to the draft report late last year. Most notably, the maligned “two-strikes” rule has been “watered down” to require a third, majority vote from shareholders. But while the commission made several useful suggestions, the report in totality will do little or nothing to curb executive pay, which, according to the commission has risen from 18 times’ average weekly earnings to 110 times’ average earnings (for Australia’s largest companies).
The commission’s review was a political solution to a thorny problem for Australia’s notionally left-wing government. With economies around the world crashing and executive pay continuing to increase relative to ordinary wages, Kevin Rudd needed an excuse to silence critics (many of whom have been complicit as executive remuneration rocked over the past two decades) that the government was soft on executives.
It is fair that the government got the report it deserved.
First, the good stuff — and there were some positive recommendations made by the commission. Most notably, removing the “no vacancy rule”, which prevents companies from limiting the size of the board to prevent outsiders (even those who are supported by a majority of shareholders) from being appointed. The commission also recommended that executives be banned from sitting on remuneration committees — a long-overdue change given that many instances of extreme remuneration (Babcock & Brown, Westfield, Leighton, Village Roadshow) occurred with executives sitting on the company’s remuneration committee. Preventing executives from voting on remuneration reports or hedging equity incentives are also shrewd recommendations.
The commission also followed a suggestion of Crikey from several years ago and recommended that “companies to disclose executive remuneration advisers, who appointed them, who they reported to and the nature of any other work undertaken for the company”.
But while the report was not without merit, when it comes to actually curbing runaway pay, it will be of little or no effect.
The much talked of two-strike rule, which unjustifiably garnered substantial media attention, is little more than a useless red herring. The commission’s final report was altered to sensibly require a 50% vote from shareholders (on top of two consecutive 25%-plus remuneration protest) before the board is split. But while two-strikes rule is ominous on its face, it will be utterly useless. This is because shareholders virtually never vote to remove directors (even for legitimate reasons such as business failures at other companies). As Regnan boss Erik Mather noted to The Australian, “directors are going to get struck by lightning twice before this rule is ever going to impact them. And effective directors are never going to be impacted by this”.
Then there is the other point that shareholders currently have the ability to propose a board spill by garnering 100 signatures or 5% of shareholders anyway.
There is nothing in the actual report that gives shareholders any real power of executive pay, especially with regards to larger companies, which the commission acknowledged was the source of most angst.
The report conceded that runaway executive pay is largely confined to bigger companies (average pay for CEOs of smaller ASX200 companies was $250,000 — a relatively trifling sum compared with earnings of many investment bankers, fund managers or even legal and accounting partners). Sadly, instead of addressing the issue of agency costs increasing with market capitalisation, the commission attempted to justify the distinction, noting:
Liberalisation of Australia’s product and financial markets together with the introduction of competition in many formerly government-controlled sectors in the 1980s and 1990s, drove substantial domestic structural change, including corporate consolidation and the emergence of internationally-competitive companies with global operations.
Today, for example, BHP Billiton (Australia’s largest listed company) has a market capitalisation of $200 billion, compared to $16 billion in 1989 at the end of the high protection era. Wesfarmers’ capitalisation increased from $800 million to about $26 billion over the same period. The pay-offs for these and other large companies operating in competitive markets from having a highly-talented CEO and senior executives (and the losses from having inferior ones) are potentially commensurately large.
The focus on “size” over return on equity is a large reason for some of the most unjustifiable executive packages. Especially when companies grow large due to what are in reality, value destroying acquisitions rather than development of new revenue streams and improving efficiencies through innovation. Both examples cited by the commission (BHP and Wesfarmers) experienced substantial increases in capitalisation but in both cases, part of that increase was directly due to foolish takeover decisions (BHP with Billiton and Wesfarmers with Coles Group), which cost shareholders many billions of dollars. The executives who spearheaded the decisions were not necessarily highly talented employees, but gamblers who risked shareholder monies on dilutive acquisitions — all the while knowing their salaries would increase because they were managing a larger entity.
The CEO Union of Australia (also known as the Business Council of Australia) appeared to deny that there was even a problem with executive pay, with new president Graham Bradley claiming that “when executives have been rewarded, it has mostly been because they delivered for shareholders, including superannuation funds held by millions of Australians”. Perhaps Bradley should ask shareholders in Babcock & Brown (which paid executives hundreds of millions of dollars in the three years before its collapse), Telstra (which paid former CEO Sol Trujillo more than $40 million as its share price crumbled) or MFS (which paid millions of dollars in performance bonuses months before the company sunk) about their views on executive pay and value deliverance.
Corporate Governance Minister Chris Bowen is currently considering the Productivity Commission’s report and is expected to adopt many of the recommendations by March.