Last week the business lobby reacted with predictable fury at the decision by Fair Work Australia to grant the lowest paid workers an additional $26 per week (a rise of 4.6% in 18 months). However, when it comes to the remuneration of corporate executives, many who of whom have delivered sub-optimal returns for shareholders, too much is rarely enough. According to the Productivity Commission, since the early 2000s, executive pay has risen by 6% annually — before then, it rose by 13% per year.
The top 20 CEOs in Australia (that is, those managing the 20 largest companies rather than the 20 most skilled executives), were paid on average 320 times the wage of the lowest-paid workers in the country.
Perhaps sensing the public anger at the irrepressible increase in executive wages over the past two decades (and the impending introduction of the “two strikes” rule, which will give shareholders the ability to spill corporate boards based on remuneration reports), the ever helpful Australian Institute of Company Directors (AICD) last week released a position paper for proposed reform of the Corporations Act. The position paper naturally doesn’t suggest that executive wages should be reduced — rather, it provides some helpful advice to law makers as to how executive pay should be presented to shareholders. According to the AICD, when it comes to disclosure of executive remuneration, the less shareholders know the better.
The CEO of the AICD, John Colvin, stated that under the current laws, remuneration reports (which are presented to shareholders each year) are “unduly complex, place a significant burden on companies and are of limited use to shareholders and other readers. At worst, they have become almost incomprehensible to even expert readers and can give a distorted picture of executive remuneration.”
The AICD’s solution? Change the way reports are presented so that a big chunk of executive pay effectively disappears from view. That is not to say that executives won’t receive non-cash pay — instead, shareholders will simply not be told about it in the remuneration report.
Presently, companies are required to specify the cash pay received by executives and the value of (non-vested) equity instruments such as share options or performance rights. Under the AICD’s proposals, the value of non-cash items, such as share options that have not yet vested would magically disappear — instead, they would “appear elsewhere in the company’s financial statement”. Presumably, where no one notices them.
The AICD noted that “we think that if they are adopted, remuneration reports will provide a more accurate and fairer picture of executive remuneration and, most importantly, shareholders and other readers will be better informed”. Such a view appears to contradict basic common sense. Non-cash items, such share options or performance rights have a value to executives and a cost to shareholders when they are issued, not merely when they eventually vest.
For example, if the CEO of Wesfarmers is given 100,000 options in Wesfarmers, which are exercisable in three years time at a share price of $10, and Wesfarmers share is presently $20, then those options are worth a combination of their intrinsic value (which is $20 less the $10 exercise price), plus time value. This means that the options granted would most likely be worth more than $1 million, discounted for the probability that those options may never vest. There are mathematical formulas which are able to determine a reasonably accurate value for such instruments.
From a shareholders’ perspective, options granted most certainly have a value, and more importantly, a cost (notwithstanding that the option or performance right has not yet vested). At the time of grant, there is a mathematical probability of those options being exercised — if and when that occurs, the number of shares on issue increases, and the earnings per share will fall. (The fact that many executives have since the 1990s preferred to receive non-cash remuneration appears to support the notion that these non-cash measures are valuable remuneration).
Most amusingly perhaps, was the AICD’s claim that excluding the value of non-cash remuneration would provide a “shareholder friendly overview of the key elements and outcomes of a company’s remuneration arrangements”. This appears akin to suggesting an adulterous spouse is providing a “matrimonially friendly” environment by concealing an illicit affair from their unknowing partner.
The AICD also proposed that performance conditions (aka “performance hurdles”) relating to options or performance rights should be omitted from the remuneration report if their disclosure may result in “unreasonable prejudice” to the company. While the AICD claimed that this will allow “commercial in confidence” targets to remain hidden, more importantly, such non-disclosure will allow companies with an excuse to avoid confessing lax conditions that they attached to equity incentives. (Easily obtainable performance hurdles were a key reason for the repudiation of remuneration reports in recent years at United Group, Downer EDI and Wesfarmers).
Admittedly, it should be remembered though that the AICD is a body that represents the interests of executive and non-executive directors, rather than shareholders. It is the job of the AICD to effectively ensure that executives are highly paid. In that regard, one could conclude that they have performed admirably.
Adam Schwab is the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed, featuring the stories of ABC Learning Centres, Babcock & Brown, Allco and Telstra.