A Productivity Commission report on executive remuneration has found that big companies have led the growth in CEO incomes.
NOTWITHSTANDING a lack of consistent data over the longer term, on any measure remuneration for executives of larger companies has grown strongly overall since the early 1990s.
Depending on the sample used, CEO remuneration at the 50 to 100 largest Australian listed companies increased between 1993 and 2007 by as much as 300 per cent in real terms. Since 2007, this trend has been reversed to some degree, with pay returning to levels recorded in 2004-05.
In 2008‑09, estimated total remuneration for CEOs of the top 20 companies averaged approximately $7.2 million, or 110 times average wages. CEOs of the next 20 biggest companies had remuneration packages valued about one third less (about $4.7 million). Multi-million dollar packages all but disappear for companies ranked 150 to 200, while for the smallest of Australia’s almost 2,000 publicly listed companies, CEO remuneration averaged around $260,000 (or about four times average wages).
Remuneration levels also vary significantly across industries, being highest in the finance, telecommunications and consumer sectors, and lowest for the CEOs of information technology and utility companies.
While there are no consistent long-run time series for executive pay (because of evolving disclosure rules), the different series available suggest:
• CEO pay grew most strongly from the mid 1990s to 2000 – at about 13 per cent a year in real terms for the top 100 companies and 16 per cent for the ASX50;
• from 2000 to 2007, annual real growth moderated to 6 per cent for the top 100 companies, but still led to a 50 per cent increase overall; and
• between 2006‑07 and 2008-09, real total CEO pay fell, with a decline of about 30 per cent for ASX300 companies, especially for the top 100 (which have proportionately more pay linked to company performance).
Nearly all of the growth in reported CEO pay for the top 300 companies in the years preceding the GFC was attributable to increases in incentive pay (as valued for accounting purposes), especially ‘long-term’ incentives, which tripled between 2004 and 2007. The extent to which there was any initial trade-off with base pay (cash-in-hand) or other unreported rewards such as fringe benefits is unclear, though average base pay has declined somewhat in real terms in more recent years.
Since 2007, long-term incentives (LTIs) have fallen by around 25 per cent and the decline in short-term incentives (STIs) (‘bonuses’) has been even greater.
Why such growth?
There have been a number of drivers of executive pay in Australia during the past 20 years.
In line with their global focus, many companies now demand candidates with international experience.
Broadly speaking, bigger companies seem to be prepared to pay more – both to compensate for increased job importance and complexity and to attract the most talented people. Company size seems to explain 25-50 per cent of observed increases in executive pay.
The increased mobility of executives, coupled with the very high levels of executive pay in the US (which is the outlier globally), has also had flow-on effects to Australia; for example, through the ‘importation’ of a few high-profile US executives to key CEO positions in the early 1990s. These appointments essentially introduced US-style incentive-based remuneration structures to Australia, although such a trend was probably inevitable.
That said, Australian executive remuneration levels generally remain below those in the US and the UK, being more in line with smaller European economies.
This could reflect non-pecuniary benefits or lower costs of living in Australia, or for US CEOs, the much higher share of at-risk pay (which commands a risk premium). It could also indicate that US pay has become distorted, and that Australian companies simply do not consider candidates who command such rates.
Some have argued that public disclosure of individuals’ pay triggered a pay spiral, as companies and executives sought to ‘position’ themselves in the market, with no-one wishing to be seen as hiring or being a ‘below average’ executive. This is sometimes characterised as the ‘Lake Wobegon’ effect – a mythical place from US public radio where ‘… all the children are above average’.
But there is no clear evidence of an acceleration in the growth of executive remuneration in aggregate following introduction of the new disclosure rules. Indeed, the rate of increase in pay slowed in the 2000s compared to the late 1990s. The reversal in executive remuneration since 2007 also indicates that not all companies are locked into providing above average remuneration.
Nonetheless, by improving access to market comparator information for both executives and boards, public disclosure is likely to have led to more rapid flow-on effects where, for example, one company in an industry disturbs relativities by paying an overseas appointee a significantly higher level of remuneration.
Since the 1990s, the composition of remuneration for senior executives in Australia has changed fundamentally, with a greater focus being placed by boards (and shareholders) on equity-based remuneration, such as options and ordinary company shares (LTIs), and other performance-based forms of remuneration, such as short-term bonuses (STIs).
However, while greater use of incentive pay has almost certainly led to higher reported pay over time, in practice, it might not have translated to improved company performance.
Compliant boards, or the difficulties posed for them by very complex incentive pay arrangements, could allow executives to mould performance measures and hurdles in their favour, so that ‘at risk’ pay becomes a virtual certainty, perhaps even rewarding and encouraging poor performance.
‘Efficient’ exec pay?
It has not been possible to ascertain conclusively whether boards in Australia have set appropriate executive pay levels. On the one hand, there are various indicators in favour.
• There has been a strong correlation between pay and company performance in aggregate, both in good times and bad.
• Options (which can deliver large returns in rising markets) and hidden company loans have not been widely adopted in Australia compared to the US, and long-term incentive hurdles (at least since the early to mid 2000s) have been increasingly linked to shareholder return relative to comparable companies, constraining excessive rewards for ‘good luck’.
• On a range of indicators, the boards of larger Australian companies appear to be relatively independent, with many adopting procedures (including remuneration committees) that would be expected to reduce the potential for senior executives to directly influence the setting of their own pay.
• Australian boards have also been made increasingly accountable on remuneration matters through disclosure requirements and the (non-binding) shareholder vote on the remuneration report.
On the other hand, there are some reasons for having doubts.
• Not all public companies meet best practice guidelines for remuneration setting. While many of these are at the smaller end of the scale, a significant minority of remuneration committees of large companies include an executive member, and might also receive remuneration advice from consultants who undertake other work for the CEO, or who might not report directly to the board.
• Some very large termination payments appear difficult to reconcile with company and shareholder interests.
• Incentive pay invariably is challenging to design and seems to have been introduced in the 1990s without adequate understanding by some boards, with ‘permissive’ hurdles delivering strong pay growth in that decade.
• The complexity of some incentive pay arrangements in more recent times could have allowed unanticipated upside (especially during the share market boom prior to 2007-08), yet weakened or distorted the incentive effects for executives.
The commission understands that executives view some complicated long-term incentives linked to share market performance as akin to a lottery, such that they have little (positive or negative) incentive effect, yet could end up delivering large payments to the executive at large cost to the company.
As noted at the outset, the prime motivation for this inquiry is a widespread perception that executives have been rewarded for failure or simply good luck. And certainly in some periods and for some CEOs, pay outcomes appear inconsistent with a reasonably efficient executive labour market.
Such disquiet has been fuelled by well-publicised examples of seemingly egregious pay outcomes, and can lead to other companies being tarred with the same brush. This should make all Australian companies concerned about good governance and community perceptions of their conduct.
But having examined a number of alternative measures, the commission is convinced that the way forward is not to bypass the central role and responsibility of boards in remuneration-setting, especially through prescriptive regulatory measures such as mandated pay caps.
Furthermore, the commission considers that a binding shareholder vote on the remuneration report would be unworkable given the report’s complexity and coverage, and would compromise the board’s authority to negotiate with executives.
The commission considers that the more appropriate and proportionate response is to improve corporate governance and enhance the effectiveness and credibility of boards, as well as to make boards more accountable in relation to pay setting.
Accordingly, the commission is recommending a package of reforms that collectively would significantly strengthen corporate governance and alignment of interests, giving shareholders better information and more say on pay.
n This is an edited extract from the Productivity Commission's executive remuneration report, December 2009.