Executive pay not the real problem: executive remuneration

IS there too much emphasis on executive remuneration?

IS there too much emphasis on executive remuneration?

This week, the government has released its draft legislation on additional regulation of the remuneration of executives and directors of listed companies.

Thick as we are into the silly season, it is not clear who will be paying much attention to the document.

In introducing the draft legislation, David Bradbury, Parliamentary Secretary to the Treasurer, had this to say: "Many families living in our cities, suburbs and our regions have paid a price for the actions of many corporations a half a world away, and now they are looking even more closely to Australian companies to step up and lead the world in defining a new brand of corporate citizenship."

On this tortured logic, the aberrant behaviour of corporations overseas provides a rationale for regulating further the operations of Australian listed companies. Sadly, there is no evidence given that overseas companies will take the least notice of Australia's "new brand of corporate citizenship".

To the extent that they are taking any notice at all, their likely reaction will be one of pleasure as they see more regulatory burdens being imposed on corporate Australia, undermining the competitiveness of Australian businesses.

Spurred by the populist outrage associated with seemingly excessive remuneration packages of some executives of Australian listed companies, the government asked the Productivity Commission to inquire into executive remuneration. The final report was sent to the government in January, nearly 12 months ago.

The report was a curious mix. On the one hand, we were told that executive remuneration in Australia grew strongly in the 1990s, slowed in this decade and even fell at the time of the GFC.

Most of the growth in remuneration was associated with strong corporate performances and with growth in the size of companies.

Executive remuneration in Australia was found to be lower than in the US and Britain, but on a par with European rates of pay.

Using Bradbury's words, "the Productivity Commission concluded that Australia's executive remuneration framework is highly ranked internationally."

But, on the other hand, the report contained recommendations that amounted to a highly interventionist assault on the workings of listed companies. It is difficult to see how the case for these measures followed from the core of the report.

In any case, it is these recommendations the government has picked up in its draft legislation, although it has already introduced several changes affecting executive remuneration, including restricting termination payments (which, unsurprisingly, are pushing up current rates of pay for executives). One of the key proposed changes is the two-strike policy whereby a "no" vote of 25 per cent (that is, a vast majority are voting "yes") against the remuneration report of a company in two consecutive years will trigger a spill of the board if a majority of shareholders then approve.

There are several points that can be made about this proposal. In many instances where there has been a significant "no" vote against a company's remuneration report, the results for the election or re-election of directors have been strongly in favour, with percentages in high 90s. In other words, shareholders may express disquiet about aspects of a company's remuneration policy but still be happy with the company's directors and the corporate strategy.

Another point relates to the sheer naivety of the government in thinking that this sort of mandated arrangement will not be gamed by corporate raiders keen to rid themselves of unco-operative directors to pick up companies cheaply. After all, 25 per cent is a low threshold and will require the raider to secure only a small number of institutional shareholders to make up the numbers.

Another strange section of the draft legislation relates to the enforced scrapping of the "no vacancy" rule, whereby company boards resolve to alter the size of the board. The connection between the "no vacancy" rule and executive remuneration is tenuous at best. Indeed, the Productivity Commission report seemed completely to lose the thread of the argument when it launched into arguments for greater diversity on boards.

At least, the government's explanatory memorandum (EM) separates these two aspects -- between board composition and remuneration -- although it maintains that increasing the chances of an outsider being elected to a board will somehow produce better outcomes.

Currently, shareholders have the right to vote off directors -- which is somehow seen as a "harsh and meaningful sanction" in the EM -- and alternative directors can put themselves up for election at the AGM. It is not clear what is wrong with these processes.

The mandated scrapping of the "no vacancy" rule will simply ensure that boards keep appropriate directors in the wings should there be a resignation or death of a director.

At the same time, the ability to attract a valuable and highly suitable director who might become available between AGMs will be unnecessarily restricted.

Even the Productivity Commission report acknowledges that boards need to support the election of new directors to achieve the best operational results.

It is hard not to conclude that the executive remuneration caravan has actually moved on. To be sure, a small number of companies continue to receive significant "no" votes against their remuneration reports but negotiations between the company and shareholders often lead to a resolution of the issues.

The value of additional, one-size-fits-all and burdensome regulation is unclear and is certainly not confirmed by the regulation impact statement contained in the EM, which reads more like a verbal walk-in-the-park than the hard evidence and figures that such a statement should provide.

Apart from the unwarranted and costly interference in the operation of Australia's listed companies, the real problem with these proposals is the elevation of executive remuneration above all other issues.

In reality, it is these other issues -- strategy, investment execution, capital management, marketing and sales outcomes -- that determine the performance of companies and it is on these issues that shareholders should be focusing.

Professor Judith Sloan is an economist and company director. She was chairman of the remuneration committee of Santos for several years.