Why Pay More to Execs Who Fail? | BTalk Australia

(13min 23) Around the world executive pay has become a contentious issue this year. It’s difficult to accept a high CEO salary from a bank that’s being bailed out with public money. It’s even harder to see a sizeable bonus being given to the head of a company that hasn’t delivered returns for its shareholders. Worse still are excessive termination payments, many multiples of the annual salary.

So how does Australia compare to the rest of the world when it comes to CEO salaries? What impact do bonuses have on the behaviour of senior executives? What should be done to try and control payouts? These are some of the questions Phil Dobbie asks Michael Robinson, executive director of Guerdon Associates.

Add your thoughts on executive pay in the Talkback section at the end of this post.

See also: Are We Paying Our Bosses Too Much? | BTalk Australia

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• Today’s Transcript

Phil Dobbie: Hello, I’m Phil Dobbie and welcome to BTalk Australia. Today, senior executives, are they getting paid too much? A month or so ago Kevin Rudd blasted companies, particularly those in the finance sector who paid too much to their senior executives. When I asked Steven Cornwall from Deloit back in September whether we paid Australian bosses too much, his answer was that it wasn’t when you benchmarked against other senior executives around the world. So, are senior executives all around the world getting paid too much? Well, let’s ask Michael Robinson who’s the executive director of Guerdon Associates. Michael, we’re not happy about executive pay here, but I think it’s an even bigger issue in the United States, isn’t it? 

Michael Robinson: Yes it is, Phil. It is a big issue in the United States and probably with reasonable reason. Here is a relatively well-governed regime and its contrast quite significantly with the US which in many respects is less well governed.

Dobbie: So why has it blown out in the US more than it has in Australia?

Robinson: If you look at executives, chief executives of companies in the US compared to the similarly sized companies in Australia they’re paid about 300 percent more.

Dobbie: Wow, and just because it’s a more competitive market there it’s hard to get top talent?

Robinson: No, it’s probably because of the government’s regime. If you look at the United States, and this is one thing, by the way, that the US regulators have not tackled and that there’s no inclination to tackle; in the United States the chairman of the board and the chief executive tend to be the same person. In Australia they tend to be different people.

Dobbie: Right. 

Robinson: And the person that, obviously the non-executive chairman of the board in Australia, takes their judiciary duties to the shareholder very seriously and puts in place independent directors to review the chief executive’s pay. In the United States if you’ve got the chairman and the chief executive being the same person it does result in a conflict of interest on the board. The other thing about the US is that they tend to appoint their directors on the board and they don’t have a majority voting system. That means that virtually anyone the chief executive nominates to be on their board in the United States becomes a director whereas in Australia it has to be approved by a majority of shareholders.

Dobbie: Right.

Robinson: And so, you get much more independent boards in Australia whereas in the United States often they have relationships already established with the chief chairman and chief executives.  So, they might be quite deep friendships for example. And that this form of governance in the United States has contributed many commentators believe to be the relatively high rates of chief executive pay in the US. Another factor too, is the US legal system under the US laws that most companies are incorporated in the State of Delaware which tends to have laws that favour management over shareholders. That’s not the case in Australia.

Dobbie: So I think a more global issue though, I mean it certainly is the case in Australia while we might have CEOs who are paid what seems a reasonable salary, they can get pretty high bonuses based on strong performance. But they don’t tend to get penalised on poor performance. So, is that creating a bit of an unbalanced risk and putting obviously, you know, potentially putting companies into dangerous situations?

Robinson: Yes — the short answer’s yes, and I think this is one of the major issues that has been raised from the credit meltdown. When you look at banker’s pay globally they tend to be paid on the upside and not penalised for the downside. And this is one area of executive pay that is likely to change over the next few years. And there’re various ways to do this, but probably one of the more common ways that will be adopted will be where they bank the bonus. In other words, you don’t get all your bonus in one year. You reserve part of it for future years. It’s only paid out to you if the performance is sustained.

Dobbie: Right.

Robinson: And that’s likely to be a big change in how executives are paid in the future.

Dobbie: Yeah, because that cuts across the other issue as well isn’t it? You can have short term results. It’s easy to create, well it’s relatively easy, to create a fast turn around for a business it’s harder to sustain it. So, I guess that what you’re suggesting there is one way of guarding against those short term results; the CEO could turn around the business, leave, and the whole thing falls into a heap.

Robinson: That’s correct. And again, that’s another point of difference between the US executive pay and Australian executive pay or British executive pay for that matter.  In Australia and the UK there tends to be much more pay on long-term incentives than there are in the US. The US commentators may disagree with this because they point out that US executives receive a lot more stock options. But they tend not to be given to executives for long term performance. All the executive has to do in the United States is just stick around and they get them, whereas in Australia and the UK they not only have to stick around, but they also have to meet performance targets over the long term to receive these.

Dobbie: Right, so you can have a lot of executives who have had a really good first year and then they’re just sticking around waiting for their options to mature.

Robinson: That’s right, and because also options are so volatile and open to market sentiment then you could get some short-term behaviours even though it’s a so-called long term plan in the United States. But when they’re about to invest all they have to do for example in the US is maybe differ some capital expenditure to do short-term results.

Dobbie: Yeah.

Robinson: The stock price goes up, they exercise their options and it’s very short term actions that result in quite good rewards there. There are more controls in Australia and the UK than there are in the US to prevent that from happening.

Dobbie: Now, takeovers are a great example of this aren’t they? They’re often a contentious example. The CEO is paid for completing a sale or a bid sometimes it can take several years to see whether, you know, the results of that is an increased return for shareholders. What would you recommend to boards who have a CEO who’s pushing towards a takeover of another company?

Robinson: Not to pay a short-term bonus on a takeover. I think that it sends the wrong signal to the chief executive and it may be detrimental to share holders. You certainly may pay a success fee or bonus but defer the payment subject to sustained long-term performance or creative earnings over, after say 18 months or two years after the acquisition has been integrated before you pay it out.

Dobbie: So you would probably need some sort of short-term incentive to try and drive the sale out and there’s a lot of work, I guess, in what would appear to be intense activity. So, what’s a realistic short-term payment? Is it just a very small percentage of the value of the sale or is it just a proportion or an incremental proportion of the salary for that year?

Robinson: Well, it would vary with the circumstance. And while it is a lot of work we would suggest that there not be a bonus payment just for a successful acquisition. The proof of the pudding on an acquisition is made into longer term, you really have to see how well it works out. And there are plenty of examples where acquisitions have actually destroyed shareholder value.

Dobbie: Now we’re seeing a lot of press coverage of late, particularly in this country, the relationship between a CEO’s salary and their payout on termination.  Not always terminations that are amicable, we’re finding, you know, multiples sometimes of six times the base salary. Why is that happening? Is that because these companies are in such a rush to try and find the right CEO that they really didn’t negotiate that well at the beginning?

Robinson: There have been some — well, first thing, to agree with you, there have been some egregious examples of excessive payouts, but fortunately they are quite rare.  Literally standard in Australia, the maximum payout on termination might be 12 months pay. And that’s pretty standard across chief executive’s in the ASX 200, but there are some examples where this is greatly exceeded and fortunately there is provision under the corporation’s act here where if it’s a particularly large payout, it’s about seven times pay, it needs share holder approval. So, there’s that safety net where shareholders get a say in very large payouts.

Dobbie: It’s a pretty wide safety net though isn’t it, seven times the pay.

Robinson: That is pretty wide I think; some commentators, ResMetrics which is a proxy advisory firm, for example, is lobbying for the government to change regulations as such that if it’s more than 12 months pay it requires shareholder approval. And there’s quite a bit of debate going on about this right now.

Dobbie: Now wasn’t this approach tried in the US back in the ’80s — they tried to place a cap on the multiple of salaries but it almost had the reverse effect.

Robinson: Yeah, and this is where regulation can go awry and drive the wrong behaviours. In the late ’80s there was quite a lot of concern about again egregious examples of excessive termination payments. So, the US congress passed a law to say that any termination payments above three times pay would not be tax deductible and the actual executive would get taxed at a higher rate. Now what happened was that up until then most companies had very modest termination payments for executives. But because they set this limit of three times, everyone took it as saying well up to three times is OK. So, while they meant to set is as a minimum it became automatic, I’m sorry meant to set it as a maximum it became the de facto minimum.

Dobbie: Right.

Robinson: So, termination payments increased markedly within the space of a couple of years in the United States.

Dobbie: So, exactly the opposite of what they intended to happen.

Robinson: That’s correct.

Dobbie: Is that still the case though now?

Robinson: It’s still the case. And you think they would learn from their mistakes but four years after that in the United States they passed another law saying that executive pay is still too high, from now on any pay, any salary, that’s above a million dollars won’t be tax deductible. Well, this was in 1992 and most chief executives of large companies were paid way below a million dollars on their salary. And automatically this maximum became the new minimum. So, over the space of a few years you had executives being paid salaries of close to a million dollars. And on top of that, the law didn’t cover share base payment, equity payments and so on. So, on top of their salary you then saw boards lavishing huge stock option packages on their executives.

Dobbie: Kevin Rudd is quite keen to try and see that senior executives aren’t over paid in this country. Is there legislation he should be introducing? Or do you think it really is a question for market forces?

Robinson: I think you have to be very careful with any regulations. It does drive the wrong behaviours as we’ve seen in the United States. I think to date Australia with the UK have been very sensible with their laws and just focused on disclosure. And I think what Mr Rudd is proposing or will probably come up with is greater disclosure, with the exception of the financial services sector the APRA regulated companies, banks in particular, where APRA may require higher capital requirements for banks if they judge the executive compensation structure to be too risky. So, it’s not really capping executive pay it’s really how executive pay is delivered.

Dobbie: And I guess the issue is no one really rejects to somebody being paid a high salary if they’re providing even greater returns for the shareholders. It’s when people are taking a high salary or a high termination payment and, you know, everyone looks and says well actually this guy didn’t do a lot for the business, he really brought failure.

Robinson: That’s right, ou wouldn’t have an argument from institutional investors certainly and the proxy advisory firms really don’t have a problem with levels of pay per se, it’s really how it’s delivered and what it’s delivered for.

Dobbie: It’s an interesting climate I’m sure we’re going to see a lot of changes in salaries over the next 12 months we watch with interest. Michael, thanks very much for your time today.

Robinson: Thank you, Phil.