25/03/2009 - 22:00

Ensuring value for money in the long term

25/03/2009 - 22:00

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The knee-jerk response to executive bonuses is missing the real issue.

THE issue of executive salaries continues to bubble away in Australia, even though it's generally acknowledged the excesses of the US have not occurred here.

I've already expressed my views on CEO and management team payments. I blame investors, especially the institutions, for failing to adequately control salaries and bonuses. Instead they want to complain after the fact, like crying over spilt milk.

In the US, this has gone a step further. Executives of companies that have been rescued by the government are being paid huge bonuses based on the financial performance of the previous year.

I agree it's obscene but, again, I blame the investors. Investors install their people at board level and, institutions especially, have huge resources to examine the progress of the companies that they place their customers' money in.

If they don't like the way executives are remunerated, they ought to speak up and change the system.

What the global financial crisis, notably through examples like insurance giant AIG, has done is expose the inadequacies of the previously accepted systems of executive payment.

So how do we change things?

Take the example of AIG. Those executives presumably have signed contracts saying they will be paid bonuses for achieving specific targets by a given date. In the case of AIG, I'll assume that those targets were reached by June 30, before the financial meltdown almost brought the company down.

There is no doubt that many of the activities for which those executives were rewarded ultimately contributed to AIG's problems and subsequent bailout.

Nevertheless, unless there was actual fraud, such as the case of failed energy trader Enron, those executives were working towards goals set by the CEO to achieve aims driven by the investors.

In hindsight, those targets were wrong, possibly because they were focused on short-term outcomes rather than long-term results. And guess what? So were the fund managers who have their performance rated every day in many cases, and certainly are aimed at achieving quarterly and annual targets, benchmarked against their competitors.

This is the great conundrum of the era. How do we reward long-term performance? That is especially the case where many of the executives and fund managers in this equation have a short-to-medium-term outlook, not just for their jobs but in many cases their careers.

That is the truth. Many people in these roles have realised that they can earn a lifetime's income in less than a decade.

They'll sacrifice many things, such as time with family and friends, to achieve those rewards.

Most of us are in our careers for the long haul, but these guys opt for a shorter, faster version of working life, and often burn out because of it.

I am not defending that kind of behaviour, but rather offering it by way of observation.

The average length of tenure of the Fortune 100 CEOs in 2006 was around five years. In the same year, Booz Allen's study showed the average tenure of Australian CEOs was 5.9 years, against the global average of 7.2 years.

Five or six years sounds like a lot, but for someone bent on accumulating as much wealth as possible it's not that much. Therefore the incentive, in my view, is to adopt practices, culture and strategies that produce short-term results.

Of course, such managers are not operating in isolation. They are the product of a chorus line of fund managers and smaller investors chanting growth, growth, growth in the background, as they demand short-term performance.

The fundamental issue here is, what is the alternative?

Rewards for long-term performance are tricky. If a CEO does a bad job it may not be obvious for some time that he or she has sacrificed the long-term value of the company.

If the CEO does a good job, how can he or she be sure that the strategy put in place will survive when a successor takes over.

What if the next CEO or management undoes all the former team's work? Having rewards contingent on the performance of a management team that is not accountable to you would be unacceptable to most CEOs.

For instance, should former Wesfarmers CEO Michael Chaney's remuneration be linked to the success of Richard Goyder's strategy of acquiring Coles? I think not.

In my view, the only time you may be rewarded is during and immediately after your period of tenure. After that, you join the ranks of other investors, reliant on a management team overseen by a board you may or may not be able to influence.

 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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