Executive Remuneration - A Runaway Train?

Of all the shareholder governance issues, executive remuneration is the one that arouses the most passion but is often the hardest to evaluate or deal with. News that Fonterra’s CEO (Chief Executive Officer) received over $8.32m, or $160,000 per week, for the year ended July 2017 has sparked a number of headlines and even some political comment. This particular payment was comprised of a mix of base salary ($2.46m), benefits ($170k) and short and long term incentive payments ($1.83m and $3.86m respectively). While Fonterra is a cooperative and not a listed company (the Fonterra Shareholders Fund is a separate entity) their justification has followed the well-trodden route of employing consultants to conduct a benchmarking exercise and providing some vague commentary around performance targets. Objective measures that can be viewed by external parties, like the FSF share price or the Milk Price paid to farmers don’t show any positive multi-year trends so it is hard externally to ascertain if the payment is justified or not.  

In recent times we have also seen large packages paid to the departing heads of Fletcher Building ($2.94m on top of a $4.29m package) and Sky City (a total package including departure payments of $7.36m),  in spite of performance issues at both businesses.

NZ CEOs’ remuneration in our top ten listed companies has doubled over the last decade, even for some businesses that are natural monopolies – for instance the remuneration of the CEO of Auckland International Airport has trended from just under $1m in 2007 to around $3.3m this year. The remuneration of board chairman for top 10 businesses has also grown by over 6%p.a. over the last 5 years.

Stakeholders in listed businesses will quite rightly look at these payments and ask a number of pertinent questions:

• Are the payments fair and do they represent value for money?
• Have the payments driven tangible results that can be observed by stakeholders?
• What is the real market value for the executive (ie what is their replacement cost?)?
•  Do the payments encourage the wrong sort of behaviour (for example, short term profit maximisation or underinvestment)?
• Should executives who have failed to deliver value be paid as if they had on the way out the door?
• Are the remuneration structures fair to shareholders or do they transfer value to management regardless of whether they do a good job or not?
• Are we paying entrepreneurial salaries for managerial roles?

While in NZ the market tends to focus sporadically on the local headlines, the trend in executive remuneration for large listed companies is very clear in NZ and globally – it is an upwards spiral. In the USA, executive remuneration has increased at about 10x the rate of inflation over the last 30 years. The S&P500 is the main share market index used for the US share market. The top 25 CEOs of S&P500 companies earned on average $USD66m last year and the average S&P500 CEO earned over $USD13m. In 1965 the average S&P500 CEO earned about 20x the average worker, today 335 times. So are these extremely well paid people delivering superior results? The evidence would suggest no. One of the best ways to evaluate a company’s performance is to look at its Return on Equity. This measure is largely unchanged over the decades suggesting that all that is happening is that the pay scale inside corporates is getting steeper and that returns that should be divided more equally amongst the workforce or paid out to shareholders are going to senior managers. It is also disturbing to see CEO’s who perform poorly getting handsome rewards on exit, whereas underperforming workers just get sacked. Sometimes it seems that CEOs just can’t lose – perform well and get well paid, perform poorly and get a great exit package.

We are strongly supportive of shareholders having the ability to have a say on pay as this increases the transparency of remuneration arrangements and performance targets. Australia introduced the Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011, better known as the “two strikes law” to give shareholders a say on executive pay. We would like to see the same framework introduced in NZ.

We also believe in supporting local management. By and large NZ companies that have grown and promoted their own management talent internally have done well, whereas very expensive imported talent has found it more difficult. Prominent examples where international executives have struggled are Fletcher Building, Sky City, The Warehouse, Telecom (performed poorly under Paul Reynolds, who was paid about $30m over 5 years, and now as Spark is very ably managed by local boy Simon Moutter) and Fonterra.