When it comes to executive pay, the market is broken. The game, you might say, is rigged.
Chief executives and their assorted lobby groups are fond of saying “That’s the market” when it comes to defending the massive salaries. “Look at America,” they cry. “You have to pay top dollar to attract the best talent!”
Indeed, look at America. The Wall Street protests are now in their fourth week. And even though the protesters have struggled to identify, let alone voice a clear message, they know something is awry.
But more of this later. Australia is in far better shape than America thanks to high commodity prices, yet it faces the same challenges to its free-market system.
And nowhere is the market’s failure more clearly enshrined than in the debate over executive pay. Here – the system’s ultimate incarnation of self-interest – is where the rubber really hits the road.
Once again this year, executive pay is rising strongly while share prices are down and returns to shareholders falling. If markets were functioning properly, executive pay would fall when returns to shareholders were falling; pay would match performance, risk would match rewards. Yet they don’t.
When it comes to executive remuneration, pay has failed to match performance for 20 years – ironically ever since the mandatory disclosure of salaries was introduced in the early 1990s. We will get to that too, in due course.
Ever widening gap
In the meantime, a few data points to prove the case:
The Australian Council of Super Investors (ACSI), the body which represents industry super funds, marked its ten-year anniversary last month with a ten-year study on executive pay.
It found the decade to 2010 saw median CEO fixed pay in the Top 100 ASX Australian companies rise 131 per cent and the median bonus increase 190 per cent.
This far outstrips the 31 per cent increase in the S&P/ASX100 over the 10 years.
“The findings … also indicate that while CEO cash pay – the value of pay disclosed excluding share-based payments – has fallen from the peak of 2008, it remains much higher than any year before 2007,” said the ACSI report. “This is despite the S&P/ASX100 declining 30 per cent over the three years to June 30, 2010.
“Median cash pay for top 100 CEOs in 2010 was $2.786 million, down 2.4 per cent from 2009 and 4.1 per cent from the record peak of $2.904 million in 2008. Despite this decline, median cash pay for a CEO of a top 100 company in 2010 was 12 per cent higher than any year prior to 2007.”
So, we have workers’ pay rising roughly 3 per cent a year, and the average super fund return over the decade little more than 3 per cent as well. Nonetheless, executive salaries put on double digit returns.
How can this possibly be regarded as a functioning market?
The market is broken. Supply and demand are not intersecting efficiently. On the supply side, there are plenty of contenders for CEO roles. Scarcity is a bogus argument – especially as there is no credible evidence that paying more money achieves a better result. The argument of higher pay for higher performance is based more on lobby group chimera than empirical evidence.
The mostly alpha-male types who inhabit high executive ranks are there as much for the competition, the power and the vanity, as they are for the money. Will $10 million really make a Gail Kelly or a Ralph Norris perform twice as well for Westpac or Commonwealth Bank as $5 million?
Sol Trujillo, the former Telstra CEO drafted in at great expense from the US, is the quintessential example of frittering away shareholders’ money on a false proposition, that is, that Telstra had to go to the US and pay top dollar to get the best.
Trujillo cost nearly $30 million in cash earnings in his four-year tenure, notwithstanding questionable no-tender deals for related parties, while Telstra shareholders’ wealth went backwards.
Executives aren’t the owners
Now it is true that top executives face pressure, long hours and enormous responsibilities. Of that there is no doubt. They should be compensated for these aspects. Theirs is a cutthroat game, an occupation whose rewards should reflect its risks.
The question is one of degree. It is simply one of numbers – the market.
The CEOs of our Big Four banks are paid $10 million salaries despite presiding over corporations that cannot go bust. As finally made explicit in the financial crisis via the government guarantees, we, the taxpayers, stand behind our banks. We guarantee them. They cannot go bust.
No small business in this country is afforded such protection, such an elevated status of taxpayer support. This is not a real market because failure, or lack of risk of failure, is not priced into executive salaries.
It should never be forgotten – although it often seems systemically overlooked – that executives are not the owners.
The owners of the company are the shareholders. The board of directors, on behalf of the shareholders, appoints the executives and decides the salaries.
This is the theory, but sadly the reality is the executives behave like the owners and the directors too often act in the interests of the executives rather than the owners, the shareholders.
This “market for executive labour” is also broken because of the large voting blocks of company shares that are controlled by funds managers, or “institutions”.
Money managers join top league
There is a problem here. Many years ago, these money managers were typically low-key types, but the explosion in super money in the 1990s entailed a concomitant explosion in funds managers’ fees and salaries.
Suddenly this was a large industry, feting itself with awards and excessive fees. Soon the funds managers who were either good self-promoters or whose funds had performed better than the average were able to earn million-dollar salaries themselves.
The stars at MLC, Perpetual or Colonial Funds Management were now in the same remuneration league as the executives of the companies whose shares they controlled.
They too, just like the executives, were simply stewards of other peoples’ money. Yet the stewards had the control. They were now running the show.
These institutional investors, although single shareholders, often speak for large blocks of shares, perhaps half the issued share capital of your average listed company.
Unlike the vast body of smaller shareholders though, the funds managers have regular meetings with big company management. They get to talk to executives and whereas executives only have to face all shareholders once a year at the annual general meeting, they are in constant contact with the funds who are their major shareholders.
Executives then really only have to keep a few big funds managers “sweet” to get their pay rises approved. Even if small shareholders revolt, via a rejection of the non-compulsory “remuneration report”, their pay rises are pushed through by the institutions.
Again, institutions do reject executive excess from time to time, but this is the exception, not the rule.
In a sense, the funds managers – many of whom will privately confide their million-dollar pay deals are somewhat over-the-top – have a vested interest in seeing executives overpaid. It vindicates their own excess.
The upshot of this voting control however is an inefficient market for executive pay.
As a breed, funds managers are not given to rocking the boat. And the mere gratitude which accompanies the honour of a one-on-one meeting from a high-flying executive is enough to sway a ‘yes’ vote on a proxy form.
And so it is that executives “do the rounds”.
What are my peers getting?
How did it get to this? When it comes to financial markets, disclosure is almost always a good thing. In the case of executive pay however, it was a bad thing.
When mandatory disclosure of a company’s top salaries was introduced in the early 1990s, all of a sudden every executive could see from the annual reports what every other executive was earning.
It was a disaster, immediately, spawning an entire new industry of “remuneration consultants” or “RCs”.
BHP is known, for instance, to use up to five RCs just to tell it how to price labour in its very own market.
Underpinned by that basic human principle that there is nobody that argues that he or she is overpaid, the public disclosure led to a spiral in executive pay which is still out of control two decades later.
The only ceiling appears to be a company’s finite resources and, sometimes, shame.
The RCs go from company to company doing reports which corroborate every executive’s view that they should be paid more, on whatever measure. And there is always a measure which can be brewed up to rationalise a bonus for this or that.
Indeed the RCs have been instrumental in adjusting the mix of remuneration. A weekend BusinessDay study, for instance, showed that total remuneration actually fell in median terms by 1.3 per cent to $3.52 million in Top 100 companies last financial year.
Bear in mind, shareholders wealth fell a lot more than that. Still, the actual cash component of the pay, both base salary (plus 9 per cent) and cash bonuses was up.
In the lean times the RCs skew executive pay to a more secure and cash-based mix while long-term performance based on share price tends to be favoured when the market is running hot.
Anger on Wall Street
And so, looking at the market for executive labour, there are undoubted inefficiencies. Risk and reward are not evenly priced. The game is rigged.
And this inefficiency is fundamental to the crisis of capitalism generally, hence the Wall Street protests.
In the US, political donations have entrenched corporate power in Washington to such an extent that democracy has been kneecapped. The political process can no longer make decisions in the broader national interest.
Washington is virtually broke, unable to govern decisively without blowing out the debt ceiling, while corporate balance sheets are ship-shape and corporate and high net worth taxes are lower than ever.
The rich are richer, the poor are poorer and with unemployment – even on official figures at 9 per cent – so high, people are finally taking to the street.
Had Wall Street not been rescued by Main Street, had capitalism in its pure form been permitted to function and had Washington not resorted to corporate welfare, it would have been a different story.
Democratic process contaminated
Capitalist system progressed to ultimate form. Now the political power of the corporations has contaminated the democratic process.
We should be mindful that it does not happen here. Unfortunately, if the weekend splash in the Herald is any guide, we are already well down that road.
That a business leader, chairman of the Business Council of Australia Graham Bradley was considerate enough to offer Prime Minister Kevin Rudd “a lifeline” in June last year – in return for Rudd backing off on the mining tax – would suggest the democratic process has already been rattled hard.
Rudd was soon axed after declining Bradley’s offer. Julia Gillard took over the government leadership and quickly backtracked on the mining tax.
That a business leader – especially one acting in the interests of three multinationals with majority overseas ownership (BHP, Rio and Xstrata) – can affect the political process in such a dramatic way behind closed doors … it’s not a good sign of things to come.
The great paradox, of course, is that in influencing the political process and keeping their companies’ tax burden low, the CEOs of BHP Billiton, Marius Kloppers, and Rio Tinto, Tom Albanese, have earned every cent of their $10 million-plus salary package.