The Federal Government released the terms of reference for the Productivity Commission’s review into Australia’s workplace relations framework in late December 2014. The terms of reference are broad, with some commentators noting that “everything is up for grabs”.
The initial reaction when such reviews are announced is to dismiss them as irrelevant to executive remuneration, aside from how the results of the reviews affect company performance when it comes to managing staff resourcing and costs.
This is not the case.
The Commission is required to investigate how the framework affects:
- unemployment, underemployment and job creation
- fair and equitable pay and conditions for employees, including the maintenance of a relevant safety net
- small businesses
- productivity, competitiveness and business investment
- the ability of business and the labour market to respond appropriately to changing economic conditions
- patterns of engagement in the labour market
- the ability for employers to flexibly manage and engage with their employees
- barriers to bargaining
- red tape and the compliance burden for employers
- industrial conflict and days lost due to industrial action
- appropriate scope for independent contracting
and suggest improvements to the framework. The final report is scheduled for delivery to government in November 2015. Any changes will go to the next election.
Three of the above items are of particular interest for executives: “fair and equitable pay”, “productivity, competitiveness and the business environment” and “the ability of business and the labour market to respond appropriately to changing economic conditions”.
- Fair and equitable pay
We have previously noted the rising interest around the globe in ratios between CEO and median worker pay. The amount of research on the topic of pay inequality, including Thomas Piketty’s Capital in the 21st Century, is vast.
In Australia, wage growth has slowed. The wage price index increased 2.5% over the year to September 2014. Full-time adult average weekly ordinary time earnings increased 2.4% over the year to May 2014. This is only just higher than the CPI increase to September 2014 of 2.3%. Since the ABS’s Wage Price Index data series began in 1997, the year-on-year change had consistently been over 3% until September 2013.
It is no coincidence that recent and forecast increases in the fixed remuneration of executives have also been modest. Executive pay does not exist in a vacuum. Shareholders expect that while wages are depressed across the economy, growth in executive pay will be restrained if it occurs at all.
- Productivity, competitiveness and the business environment
Multiple commentators, including ourselves (see our productivity discussion paper), have noted in the past that wage increases can only come from improvements in productivity.
In prior years, rising terms of trade have bolstered lacklustre productivity performance in Australia. However, as above trend growth ends, the free wage ride also ceases.
As we have previously argued, executives are not free from the obligation to increase productivity. Total productivity, or multifactor productivity, is made up of labour productivity and capital productivity. Unlike the average worker, executives have the opportunity to lift capital productivity as well as labour productivity.
Though still low in historical terms, the labour productivity over the last three years has been considerably better than the preceding seven, according to ABS data. Capital productivity on the other hand has declined year-on-year over the last decade.
Much of this has been blamed on the capital intensive investment stage of the mining boom. Now that this is phasing out, the onus will be on executives to exert the discipline necessary to increase the productivity of all inputs.
It may be difficult to argue that growth in wages should be based on productivity for the workforce if executives do not face similar hurdles. Incentive measures that take return on total capital employed into account are becoming increasingly popular – moves to link wages to productivity could see this trend become stronger.
- The ability of business and the labour market to respond appropriately to changing economic conditions
Employers are increasingly calling for flexibility in workforce deployment so they can adjust employee numbers and hours as business requirements vary. Where employers demand flexibility, it behoves them to behave consistently across all levels of employment.
Although executives are hired by individual agreement, their remuneration structure is not always responsive to changing economic conditions. For example, while organisations are often prepared to increase remuneration as their fortunes are on the rise, where organisations encounter tough conditions, they find it difficult to reduce remuneration.
When difficulties are of short duration this is not a major issue; when performance issues are protracted on the other hand, shareholders can become concerned. Workers can also become disengaged – especially if they are subjected to a workplace relations environment where flexibility is expected.
The reduction of fixed remuneration is a difficult proposition, especially for executives facing long hours to implement challenging transformation initiatives. The easiest avenue to introduce flexibility is via adjustment to incentive plans, backed up when necessary by the exercise of Board discretion. Careful design of sign-on and termination payments is another avenue to increase flexibility and manage unplanned costs.