Management influence the productivity of organisations not only in the decisions they make to improve capital and labour efficiency, but also in how they perform relative to the cost they represent to the business.
Similar lenses to those employed to explore productivity for workers covered by awards and/or enterprise agreements should be used to view pay for senior managers and KMPs in the Australian market because:
- The cost per employee in the management group is much greater than the average worker;
- Shareholders expect a reasonable return as a direct result of the decisions and performance of senior management.
- Globally, there has been legislation around executive compensation including:
- The US’ Dodd-Frank Act 2010 mandated the disclosure of the ratio of the annual remuneration (intended) of the CEO to the median worker amidst considerable resistance by corporate management and lawyers. Implementation of this rule had been delayed, but reports have surfaced that the SEC is set to release a proposal for implementation.
- The EU Parliament and the Council of the European Union approved a legislation package that will cap banking executive bonuses to one times fixed remuneration, unless shareholder approval is sought, when it can rise to twice fixed remuneration. Discount factors are applied for deferred remuneration. This is to be in place for 2014 awards.
- A 2013 referendum in Switzerland led to the decision to legislate 24 initiatives including a binding annual shareholder vote on executive pay; a ban on severance, sign-on and merger payments; and the introduction of annual elections for Board Directors. Breaches will result in up to three years jail and fines. Legislation for the initiative has yet to be drafted; Implementation isn’t expected until 2015.
- Regulation comes into effect in October 2013 in the UK that provides more power to shareholders to decide whether executive pay is appropriate by laying out minimum requirements for remuneration policy disclosure to inform a new binding vote on pay policies. The regulations also facilitate understanding by mandating a “single figure” approach to disclosure in remuneration reports.
- Australia has been increasing its regulation on executive remuneration disclosure and shareholder power over KMP pay. The 2011 AGM season was the first year that the “two strikes rule” came into effect, strengthening shareholders’ non-binding remuneration vote such that two consecutive votes of over 25% against the remuneration lead to a vote on whether to spill the board. The previous Labour government recently proposed legislation to mandate “if not, why not” disclosure for executive clawback and the disclosure of crystallised, present and future pay, however, there are numerous concerns with the draft legislation and given the recent election outcome, it is uncertain whether this legislation will be put to the Parliament.
Of particular concern are the productivity implications of providing large incentive payments to executives for outperforming a market or industry peer group when organisation performance has created little or no absolute shareholder value. Although it is important to recognise executive performance in volatile and challenging conditions, it is necessary to also take into consideration the fact that any payments made will result in costs to the company during times of stagnant or falling outputs.
We discussed this issue in our July newsletter and note that BHP has acted to allay similar concerns with recent adjustments to its long term incentive awards. The company decided not to grant the full amount of equity that would normally have vested to executives under their incentive plan in acknowledgement that although BHP had outperformed its peer group on the relative Total Shareholder Return (TSR) measure, the absolute movement in its TSR over the performance period was negative.
This gesture highlights that although the market will always dictate boundaries, there is much greater flexibility to set KMP and management remuneration to reward productivity, such that with falling outputs we should observe declining performance aligned KMP remuneration.
In the above context it needs to be acknowledged that the nature of work of a significant proportion of those in the workforce has changed, with the increasing use of technology, new processes and systems, as well as changing work practices. In relation to senior management those with the greatest visibility are now leading companies which are much more complex than was the case twenty years ago. Australian business has become increasingly international and senior management are today accountable for the stewardship of workforces and the conduct of business in numerous jurisdictions and time zones.
Other recent examples of productivity/performance-pay initiatives in action in Australia have been fixed pay freezes and reductions in and/or no bonuses being awarded. While these initiatives have not been taken by all companies under stress the practice is widespread as Boards and management are increasingly responsive to both shareholder value creation and capacity to pay.
As part of a productivity research paper, we have conducted an analysis to determine the correlation between the Fixed Remuneration and Bonus for executives in Australia’s top companies and the market outputs they are most accountable for, i.e. operating profit, revenue and market capitalisation. This revealed that in spite of declining operating profits since 2007, CEO Fixed Remuneration has grown and bonuses are not in decline among the ASX Top 50 though are more responsive to declining performance in the ASX 200. The top 5 executives, other than the CEO, have fared less well. Movement in total cash reward for the leadership teams in the ASX Top 50 and 200 has equally not been aligned as one might expect with movement in each organisation’s revenue growth and growth in market capitalisation. The profit analysis for the ASX 50 and 200 can be found in the graphs below. More details will be provided in our research paper which will be published within the next month.
We have examined CEOs and top 5 executives other than the CEO. Where a CEO or an executive served for less than 183 days of the year, underwent a position change, left the company or was overseas based or expatriate, they were excluded. For those serving between 183 days and a full year, remuneration was annualised. Where there was no CEO data, the company was excluded from the top 5 sample, and vice versa.
17 September 2013