Politics of envy at play over CEO salaries

03/12/2008 - 22:00


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HOW much is too much when it comes to executive remuneration, especially bonuses and termination payments? This is the vexing question that's challenging the investment community more than ever before, as the market slide makes it a widespread issue rathe

HOW much is too much when it comes to executive remuneration, especially bonuses and termination payments?

This is the vexing question that's challenging the investment community more than ever before, as the market slide makes it a widespread issue rather than one isolated to just a few companies.

The current feeling is that CEO remuneration is excessive.

The reason for that is pretty obvious. Investors have lost huge amounts of the paper value of their portfolios in the space of a few months, with most of that coming since Lehman Bros collapsed on September 15.

As boards front up to shareholders for their annual general meetings, they are confronted by considerable anger over salaries and bonuses paid in relation to a year ending June 30, which itself was not too flash.

Investors are reacting by giving boards a hard time over the remuneration packages negotiated for the current period.

Companies have been caught on the hop.

Of course, investment bankers and many in the financial sector have exacerbated this situation by generally recording the highest bonuses at a time when they are perceived to be the biggest cause of the downturn.

The reaction to this is predictable.

In part, the politics of envy and the need to blame have combined to create an atmosphere where calls for restrictions on executive pay are being heard very loudly.

There are many variations on this, with many wanting to see CEOs' pay restricted to a magical figure like $1 million, at its most extreme.

On the more sensible end of things, RiskMetrics has suggested that termination payouts above $1 million ought to be subject to a shareholder vote.

All of this is understandable but flawed in the extreme.

Making laws or restrictions based on numbers plucked out of thin air will lead to bigger mistakes in the future.

The first big issue is that focusing on the number distracts stakeholders from the real the issue - performance.

Big pay packets don't necessarily mean shareholders are being ripped off. Investors need to put what they pay into the context of their executive's achievements rather than focusing on the dollar amount they compare to their own earnings.

During the past decade or more there has been an escalation in executive pay packets. Many believe that, partly, this was a result of increased transparency whereby publication of remuneration provided a benchmarking process that only ever seemed to increase salaries.

I think this has had an effect but there is something else that may only recently have been realised. The rise in CEO pay has also coincided with huge increases in shareholder value. For many years, the correlation of these two factors was viewed too much from the point of view of management driving the share market value. Clearly, in too many cases, it was the other way around.

As the global financial markets unwind, we are learning that much of that newly created share market value was really just a facade created by massive amounts of leverage inflating prices.

In a market pumped up by more and more debt, we came to believe the executive leadership was responsible for this growth.

Worse, as leverage made everyday well-managed companies appear cheap, investors paid more for CEOs who appeared to understand the market and were good at extracting the best for shareholders via deals - be it as suitor or target.

This was short-termism at its worst, in my view - paying a premium to CEOs who were proven dealmakers. These dealmakers were also good at negotiating their own salaries, understanding that investors' own fear and greed at the risk of short-term loss meant they would sign up for anything in the longer term - including ridiculous exit fees.

The place investors have in this ought not be overlooked.

As we have come to realise, the fear of missing out and the desire to get more blinds people from being objective and sensible. That is understandable among the millions of everyday investors but it is less excusable from the professional investors they had their money with.

Just where the fund managers and their like were when it came to executive remuneration is a bigger question. Their pay packets are not as transparent as the CEOs of the companies they invest in but it's easy to imagine they enjoyed the leveraged share market ride more than everyone.

While the focus has been on the CEO payouts, perhaps the real attention ought to be on the faceless investors, the ones who are supposed to be custodians of our superannuation trillions, and where they were while pay packets were getting sillier by the day.

With the leverage bubble pricked, it is highly likely that the factors that fuelled high salaries and excessive termination payments will have waned. Let's hope so.

As the markets realise that few of these CEOs are management geniuses, they may start to focus on those who can truly deliver value - often people already in their company whose cultural connection with the organisation means the job is more to them than just the money.

Even when companies need to bring in an outsider, they have to learn that remuneration negotiations are not just a one-way street. While I acknowledge that CEOs take a lot of risk joining a new company, they should not have built-in rewards for failure.

These are things that can't be legislated for. They are common sense and investors, represented by boards, need to recognise that the global financial meltdown is an opportunity to rebalance the executive remuneration equation.

It's far easier to negotiate a good outcome when you know the guy across the table isn't a genius and can be valued on their real track record rather than one inflated by debt and market hype.


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