CEO Reward – Comment on Exceptions

The heading of the article in the Financial Review, written by Patrick Durkin on 2 July, in my view was appropriate. Senior executive’s fixed or come-to-work remuneration among Australia’s leading companies has been in decline over the last decade.

There are exceptions and the average does not provide information on the distribution of each of the executives whose fixed remuneration has been compiled. It is readily acknowledged that senior executives, in addition to their fixed remuneration, can receive awards under an annual incentive or bonus plan though not all do. A CEO’s annual incentive can also exceed their fixed remuneration.

Many who have stewardship of a top ASX listed company, also participate in an annual equity-based incentive plan where securities are subject to a 3 year or longer period performance hurdle. Often being tied to a relative total shareholder return expectation and a compound earnings per share growth hurdle.

A proportion of CEOs, not insubstantial, do not always benefit from their participation in these plans as the performance set by the Board is not achieved over the defined period.  Some however, do benefit in proportions well beyond which may have been envisaged by the Board at the time the award was determined, or of inappropriate valuation of the securities on offer.

There have been comments that Alan Joyce benefited beyond the markets expectations due to the improvements in the share price of Qantas. This was influenced by a practice which, while adopted by several organisations would not be well-regarded, in that the securities he received were discounted, using a fair value methodology and assuming the risk of forfeiture, well below the prevailing share price at the time of grant (indicatively $1.345 allocated at $0.785).  This led to the allocation of 3,248 performance rights in lieu of around 1.9 million and a benefit, assuming a share price at the time of exercising those entitlements of around $6.00, approximated $19.5 million compared to $11.5 million. The outcome of his award in the 2017 Financial Year reflected the unintended consequence of the valuation of securities at the time of grant.

It should, however, be acknowledged given this error in judgement, the Board changed the basis for the allocation of securities under Qantas’s long-term incentive plan on the realisation of this unexpected outcome, to conform to more appropriate standards.

Reporting of executive remuneration reflects the cost of the provision of fixed remuneration, including superannuation and any other benefits. The actual payments made under an annual incentive plan and the statutory value, amortised over the vesting period, in relation to awards under a long-term equity-based incentive plan. The statutory valuations do not reflect the value realised, or not realised. These plans are subject to the prevailing share price at the time the awards vest and the proportion of the award which vests is subject to a performance hurdle.

In that context, the current disclosures of benefits arising under long term incentive plans provided to executives in leading public companies do not provide a mark-to-market view of the value of the award at the time of vesting.

Macquarie Bank have traditionally adjusted on a year-on-year basis, the underlying value of securities priced to market which operate under their deferred incentive program. This will both rise, and fall depending upon the company’s success and share price growth.

I doubt there would be any informed adviser on remuneration who would have endorsed the arrangements entered by the Board of CPA Australia. It would be my judgement that those circumstances and the termination arrangement which received significant publicity reflect that observation.

Remuneration planning is not a perfect science.  A proportion of judgements made by Boards, or negotiated by senior executives, are not appropriate. The advice sought by Boards is reflective of the organisation’s desired outcome rather than a completely independent view.

What is critical in this arena is that advisers to Boards are independent.  What is equally important is to accept that the nature of the work of senior executives, the demands they are placed under, is totally different from the average worker. Where any error in judgement a worker makes is unlikely to become a national headline, rather absorbed by the workforce.

This is not universally the case and there are many blue-collar workers, including highly-skilled trades people, whom the community rely upon for meeting the highest standards. Particularly in the provision of electricity to homes, or wiring from the street, and plumbing.  All other trades whether in the commercial, industrial, infrastructure or domestic market are subject to supervision and appropriate standards.

There are differences between the educational entry requirements for these positions and the educational demands in reaching accreditation, when compared to leaders of major corporations. This area of valuing differential capabilities applied across every occupation will always be a challenge and subject to varying community views.

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