An end to the days of plenty
On the same day the Australian Institute of Company Directors released its report into executive remuneration schemes, chief executive John Colvin tells Business Spectator's Isabelle Oderberg that:
Isabelle Oderberg: John, at the beginning of the release you say that there have been mistakes made. I was wondering if you could tell me what and where those mistakes have been.
John Colvin: Generally speaking, some of the mistakes that have been made in executive remuneration came about through just not thinking about what could happen if outliers occurred and that can happen in a number of ways. For example, if you‘re looking at CEO packages you might have an outlier of a CEO package from an international company. That probably shouldn’t be in that sample because you’re not comparing like with like. That's a common one and I think remuneration consultants and boards are, you know, getting better and better at that. The other mistake that can be made is along the lines of just not stress testing some of the packages enough. You might have a situation where the lawyers and the remuneration consultants have had a good look at the package and said the contract works well and the remuneration looks, you know, fair and reasonable and then suddenly one of the incentives might have a formula base to it and then you get a huge updraft in the market and … and that formula spikes in a way which nobody had actually thought possible.
JC: What we're particulary interested in is guidelines, just making sure the process is robust. The process of making sure that a CEO executive contract is controlled, totally controlled, by the board. That the processes and the experts and the consultants are all engaged by the board not by the executives and that those that are involved, are given clear instructions from the board as to who they are acting in relation for. That it’s confidential and that the documents and the, if you like, the discussions are confidential and aren’t used again. To make sure that you don’t have internal conflicts either, you know, specific ones like the CEO setting their own remuneration, which is in fact pretty rare, but just in terms of the HR director, you know, being involved and maybe being a little too helpful certainly has happened. And so you try and make sure that the system that you put in place is robust and appropriate right from the very beginning, then you’ve got a chance of getting these discussions off on the right foot.
IO: This is not the first set of guidelines for remuneration best practice. There are a number of guidelines doing the rounds worldwide. I’m just wondering at what point does the government have to step in and say if you’re unable to act within fair and reasonable boundaries, we’re going to have to do it for you?
JC: Well, there’s a whole lot of difficult philosophical questions there, but I’ll try and answer as quickly as I can. One, just because there’s a lot of tabloid noise about some aspect of executive remuneration, it doesn’t necessarily mean that there is a problem so ask yourself, is there really a widespread problem? Now, there are definitely again what I call outliers where even the director community might, you know, choke on their cornflakes, but is there such a widespread problem?
JC: If you look at the voting patterns in one of the biggest recessions that we’ve had, the number of shareholders voting against remuneration packages is not actually all that high. There are areas where there are high votes and prima facie you’d say that is an area for concern and boards would have to take that pretty seriously to see what needs to be done. You’ve then got to say well, when was a contract actually entered into? What’s the timing of this? What are they obliged to do? How can they then vary this going forward? And then you’ve got to say well, without being too defensive, why would executive pay be an area where there is a limit on salary when no other areas of free enterprise are? For example, you’d say well, you wouldn’t try and put a limit on one of the great sports stars. You wouldn’t try and put a limit on, you know, sort of some of our great actors and actresses.
IO: They cap football teams’ pay, don’t they?
JC: Well, some clubs in AFL and things, you know, try and do that and that’s to keep a competition homogenous. They're not trying to remain competitive globally. We don’t think that heavy-handed regulatory restrictions on executive remuneration is the way forward. They don’t work well and can, in fact, have unintended consequences. The effect is akin to “squeezing a balloon”, with restrictions imposed in one component of remuneration resulting in market pressures manifesting themselves in other areas. For example, in 1993, the US Congress said only $1 million of an executive's salary would be tax deductible. This resulted in a swing to the use of higher short term incentives, like performance-linked bonuses, and long term incentives, which were not subject to this limit.
Because limits or cash caps on base remuneration could be circumvented by increases in such performance-based components, this may have the perverse effect of “locking in” some of these existing underlying components to remuneration models which are the basis of much of the current perceived problems.
IO: We recently did a round table with Mercer and one of the issues that came up was that companies appreciate the need to communicate more with retail shareholders; that it’s much easier for them to communicate with institutional shareholders. Do you think the boards really care what retail shareholders think?
JC: Oh, I think they’re vitally concerned about the retail shareholders, but if you’ve got sort of 300,000 to 500,000 shareholders it becomes very difficult to work out how you do that other than if they turn up for AGMs. If they don’t turn up for AGMs, which many of them don’t, in fact probably most of them don’t, then it’s in terms of correspondence from the company to the shareholders and then it’s probably using proxies like the Australian Shareholders Association or others in that area …
IO: Do you think those groups are taken seriously by boards?
JC: Oh, certainly. I mean I talk to boards all the time who say they have just spoken with, you know, large shareholders, institutional shareholders, Australian Shareholders Association and some of the other proxy voters. They do that. They take it very seriously.
IO: One other issue that was raised at this round table was that there should be more focus on local talent and internal succession planning rather than just heading straight overseas to try and poach talent overseas and that would contribute to keeping the salaries on a more competitive basis with the local market. Do you agree with that?
JC: The answer to that is yes and no. I would say that every company would try and should have a, you know, succession planning, so that they can appoint their CEO from within. It has a lot of advantages. One is that it’s often cheaper. Two, they hit the ground running. And three, you’d expect, you know, good companies to have succession planning, so that if the CEO was sick or unable to continue their, you know, their work for any reason, it would be a seamless transition. Having said that boards often have a look at their culture and think well, we’re not going to get the shift that we need by promoting from within and it’s time that we use an external CEO to provide the strategic objectives and the cultural change that is, you know, maybe necessary. Or maybe even the restructuring that’s necessary.
JC: Last night we had a wonderful discussion with some of our leading retired directors who said that when they were originally directors, companies like BHP, CSR, these sorts of iconic companies only took succession planning from within and that was the culture 25, 30 years ago that was the system and how it worked. Then we had, if you like, the freeing up of the Australian market, deregulation of the banks, the Aussie dollar floating, a whole lot of competitive issues which suddenly came in and those issues required different thinking and different approaches and so you had people like Bob Joss come into Westpac in a difficult circumstance and so forth. You’ve seen less I think of that in Australia now and my impression is you’re getting sort of a reversion more to succession planning and internal candidates obtaining jobs.
IO: We’ve seen in America a number of CEOs in companies that have had their share prices sort of decimated, giving up bonuses and incentive payments where they would’ve otherwise been paid out despite the destruction in value. Are you expecting or hoping for similar actions from Australian CEOs over the next 12 months?
JC: Well, I think you’re going to see some of the structures of short term incentives, long term incentives, the bonuses and how they work ... you’re going to see under the current economic circumstances that they will be going south in any event. If they’re tied to financial performance, many of which are at least in part, then those financial performances won’t be as good, so the bonuses won’t be as high and some of them will be not in the money at all. Those that have share based incentives will find that the values have gone right down.
IO: But in situations where bonuses are going to be paid or are calculated as that they should be paid out, do you think we will see CEOs voluntarily giving up those payments?
JC: Well, you know there may be examples of that and we’ll have to wait and see. That’s a possibility. I think you’ll see boards asking very hard questions around the board table like we were a $40 billion capital company and we’re now a $20 billion company and you were paid on the basis of the company's market cap so we better have a review now about a whole lot of things. One, we need to rethink your particular circumstances and the payments and also we might need to rethink the whole structure of base pay, short term and long term incentives. Why don’t we think about another structure which is a bit more flexible?
JC: One of the things we’ve put forward is the old system of a base pay plus a discretionary bonus is not a bad way to go for some companies because there’s more flexibility to adjust the bonus in difficult circumstances like we have now. You’ve got a way to be a bit more flexible if you have that. The problem with that approach is on the other side of the equation some of the investors don’t like that approach. They like to have certainty and transparency and some of the executives don’t like that. So, it ends up being a negotiation and directors trying to do the best thing by the company and obviously the executives in that aspect are going to be more self interested.
JC: I think the fundamental thing is really that one of the issues that we are concerned about is tabloid legislation. So, if you look at the problem and you go into it in proper detail, some of the issues which are considered to be problems and endemic everywhere are simply not … That’s just not correct. We are in the biggest downturn since the Depression of the ‘30s so it would be surprising if you didn't have a large outcry about executive remuneration. It’s an easy target. Secondly, there have been some outlying behaviours which, you know, need to be pulled up and need to be corrected
JC: You know, somebody said to me "John, there are death, taxes, executive remuneration and director’s liability" and, you know, that’s the lot. I don’t expect executive remuneration to go away because there’re perceptions of people that can be varied so markedly, so some people will think anyone who earns more than $100,000 is being paid too much no matter what. We and boards on the other hand would say, where are we trying to get these people? How do we incentivise them to be there, to retain them and how do we attract them? And there’ll be views around a board table which would differ. But at the end of the day, you’ve got to make a judgement call on it in real time. You’ve got to produce a reasonable outcome for the company as a whole.
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