Executive remuneration
Press conference opening remarks
These are opening remarks of Gary Banks, Chairman, at a press conference held at Parliament House, Canberra on 30 September 2009 regarding the release of the Executive Remuneration in Australia discussion draft.
- Welcome to the release of the Productivity Commission's Discussion Draft on Executive Remuneration. I am Gary Banks, Chairman of the Commission and leading this inquiry. I am joined by Robert Fitzgerald, Commissioner, and Professor Allan Fels, Associate Commissioner.
- Executive remuneration obviously has been a hot topic for some time
- There have been widespread concerns that executive pay 'got out of hand' in Australia, concerns heightened by pay practices overseas seen as contributing to the global financial crisis.
- Some of the concerns in Australia are justified, but there is also much emotion and heat
- The debate is not always well informed (and understandably so, given the complexity of executive pay arrangements).
- The Commission's job is to step back from the clamour and take a cool, independent look. Our work is directed at three questions:
- what are the facts?
- what has happened and why?
- and what should government do, in the best interests of the Australian community?
- The Discussion Draft sets out the Commission's preliminary findings and proposals.
- The Commission's bottom line is that while there is no evidence of general failure in the executive pay-setting system across Australia's 2000 public companies, there has been excess and poor practice that point to weaknesses and warrant government action.
- In a nutshell, our research confirms:
- a strong increase in executive pay, and considerable widening of the gap between CEOs and the average worker, since the early 90s
- that this has much to do with the strong growth and increasingly global reach of Australian companies themselves, which have placed a premium on getting the best executives
- and this has been reflected in a major shift to performance pay
- but we have also seen signs of excessive and poorly designed remuneration that threaten to weaken public confidence in the corporate sector and could impact adversely on equity markets
- we have made 15 recommendations to strengthen the regulatory and corporate governance framework -- 10 of which involve black letter law
- most of these are directed at ensuring that remuneration decisions by boards reflect shareholder interests over the long term.
- But first a few 'facts'...
- CEO remuneration for the top 100 is estimated to have more than tripled since 1993
- rising on average from 17 times to 50 times average earnings
- remuneration grew twice as fast on average in the 1990s (13% per annum) than in the 2000s (6% per annum) in inflation-adjusted terms
- there was a drop (-13%) in 2007-08 as the global crisis hit Australia
- but the extent to which there were further reductions in financial year 2008-09 remains unclear at this stage (it will be covered in the Commission's final report)
- pay levels and growth vary greatly across Australia's almost 2000 public companies
- CEO pay at the top 20 companies averages $10 million (150 times average earnings)
- CEOs of the bottom 500 listed companies average $180 000 (3 times average earnings)
- so very high pay is a 'big company' story in Australia, mainly confined to the top one per cent of public companies.
- But even top Australian executives earn considerably less than their counterparts in the USA (the outlier internationally) and even the UK
- our CEOs appear to be paid at similar rates to smaller European countries.
- Furthermore, nearly all of the more recent growth in remuneration has been in 'performance' pay
- Equity-based performance-based pay arrangements were first 'imported' to Australia with high profile CEO recruits from the USA in the early 1990s.
- Performance-based pay is a potentially beneficial mechanism for aligning management and shareholder interests
- and strongly supported by shareholders
- but obviously pay linked to performance is more uncertain and risky for executives than base salary -- and therefore requires them to be paid a premium (and thus generates a higher 'headline' remuneration number)
- and it can also be riskier for companies themselves if it is not well-designed. The efficiency of performance pay in practice therefore has been a key issue for this inquiry.
- On the one hand, we have found some positive signs. For example:
- average pay growth in the top 200 companies over time has been broadly in line with market returns in aggregate
- remuneration structures are also not out of line with what shareholders say they want, and have involved a progressive shift to 'long-term incentives' (LTIs) involving deferred equity holdings (which the Group of 20 recently called for in financial institutions)
- nor have Australian companies made extensive use of options or hidden loans (compared to the USA).
- But there are also some areas of concern
- First, performance hurdles in the 1990s could be described as 'permissive' and pay arrangements have become very complex since
- It seems likely that some arrangements have generated bigger payoffs for executives than anticipated or necessary (more for 'luck' than performance)
- Second, some of the termination payments appear hard to justify (even after adjusting them properly)
- which suggests possible weakness or complicity in those boards
- Further, while corporate governance in Australia generally rates highly by international standards, it still allows certain conflicts of interest that could enable executives to exert undue influence over their own pay.
- First, performance hurdles in the 1990s could be described as 'permissive' and pay arrangements have become very complex since
- Hence, we see a case for stronger regulation.
- But we do not favour regulating executive pay directly (through salary caps)
- having the government as 'paymaster' for senior executives is unwarranted, unworkable and would end up hurting shareholders and the economy.
- Rather, the way forward is to regulate more effectively the system in which executive remuneration is determined.
- As noted, we have over a dozen proposals to achieve this.
- One is to remove the barrier to enhancing board membership posed by the 'no vacancy rule',
- which enables existing boards to prevent new candidates from outside the so-called 'club'
- Secondly, we are seeking to eliminate the potential for executives to directly influence their own pay, by:
- preventing them from sitting on remuneration committees
- prohibiting them from voting their shares (or undirected proxies) on remuneration issues.
- We are also curtailing the scope for executives to exert influence through remuneration consultants, by requiring those consultants to be hired by and report directly to boards
- and for any other work they do for the company to be declared in the remuneration report, which needs to list which consultants were used.
- We also have recommendations to improve the readability and usefulness of remuneration reports. These have become very complex and detailed, but lack information that many shareholders actually value - in a form they can understand (and that would be less prone to misreporting)
- like actual pay received by top executives
- and their total shareholdings
- and a simple explanation as to why pay arrangements are as they are, what safeguards are in place, and how remuneration design promotes the interests of the company and its shareholders.
- Finally, the Commission has given significant attention to shareholder voting on remuneration
- the non-binding vote was much resisted prior to its introduction in 2004
- but it is now seen as having been beneficial in fostering greater board responsiveness to shareholders
- we do not propose converting it to a 'binding' vote, which would be impractical and undermine the board's role (as many participants have acknowledged, including the Australian Shareholders' Association).
- the non-binding vote was much resisted prior to its introduction in 2004
- However boards are not obliged to respond to the non-binding vote, and we see a case for strengthening shareholders' leverage where there is a significant (minority) 'no' vote.
- In effect, we are advocating a 'two strikes' policy
- if a remuneration report is rejected by 25 per cent of the votes cast by (eligible) shareholders, the board would need to explain at the next AGM what actions it has taken in response (the first strike)
- but if there is a further sizeable no vote at that meeting (a second strike) then the board must face re-election
- what the second trigger should be is something we will be giving further consideration to.
- In combination with our other proposals, this all adds up to a powerful package of reforms that would strengthen corporate governance, make boards function more effectively on shareholders' behalf and give shareholders a more informed and influential 'say on pay'.
- We also believe that the reforms we are proposing would reduce the likelihood in future of outcomes that shareholders and the community find objectionable.
- But this is a draft report and these are only proposals at this stage. While we have given them careful consideration, we are conscious that this is a complex area for public policy and getting the balance right is very important. We will therefore be actively seeking feedback from all stakeholders - and no doubt we will get plenty!