Head-hunters add big chunk to executive pay bill
The executive placement industry adds as much as 15% to the country’s annual multibillion-rand executive remuneration bill, according to Deloitte’s just-released executive compensation report. For the 100 listed companies researched for the report, placements amount to a hefty R240m of the R1.6bn total annual cost of CEO compensation.
The head-hunting industry has played a significant, albeit informal, role in setting guaranteed pay levels through its aggressive intervention in the market, the report reads. What the report does not state explicitly is head-hunters have been able to exert a strong influence in favour of executives because there has been little or no pushback from stakeholders, particularly shareholders.
The report’s description of the role played by institutional shareholders implies their compliance.
A finding that will come as less of a surprise and that flows from the lack of effective oversight, is that growth in annual pay for executives, in all sectors and for all-sized companies, has far outstripped the inflation rate over the past six years. It seems increased oversight has done nothing to rein in executives’ expectations, with large multinational companies being especially generous, while smaller ones generally tried to match largecompany pay scales.
The report won’t be particularly pleasing to anyone, which probably suits the authors as their objective is not to attack or defend this prickly issue, but to raise the level of debate.
The acknowledgment that the CEOs’ pay only slightly underperformed shareholder value creation over the six years to 2016, will comfort many executives who worry about being accused of great value destruction. But it’s grudging approval, which will please critics of a system many believe has become out of control.
“In general terms, the performance of top executive pay has not significantly outstripped the growth in shareholder value, other than in MRC (mineral, resources and commodity) companies,” says Deloitte.
Even this grudging approval is challenged by the report’s other findings. Having dug through six years of remuneration reports, Deloitte created a CEO total annual compensation (TAC) index, that shows growth in executive pay marginally exceeded growth in turnover and significantly exceeded growth in earnings over the period.
At the end of the six-year period, the CEO TAC index was 167% compared with turnover of 163% and headline earnings of only 115%. To its enormous credit, Deloitte has gone beyond other remuneration studies that have focused only on total guaranteed pay and included cash bonuses in its calculation of TAC. But TAC doesn’t include share-based accruals as, say the authors, “they are intermittent and therefore their timing can distort the sense of the index”. Given that these can amount to tens of millions of rand over a CEO’s tenure, it’s likely the full return to executives beats the return to shareholders.
A similar but more detailed study of UK-listed businesses by Lancaster University Management School, released early in 2017, pointed to “a material disconnect between pay and fundamental value-generation”.
The report warned measures typically used by companies to calculate performance such as earnings per share and total shareholder returns were inadequate measures of value-creation.
What is evident from Deloitte’s study is that local executives have relied on a bullish equity market to support their generous pay packages with shareholders apparently sufficiently comforted by increasing share prices to give the nod to generous remuneration policies.
Given that much of the share price increases was due to a strong inflow of foreign investment into the JSE during the period, it’s difficult to understand how executives could have been rewarded for the resulting effect on share prices.
The sense of executive entitlement that seems to pervade the system means it’s likely that any sustained weakness in share prices, as jittery foreigners withdraw from the JSE, will see a redesign of share-based awards. Leslie Yuill of Deloitte Consulting, one of the authors of the report, doesn’t rule this out but urges caution.
“You’ve got to be very careful with redesigning remuneration policies, it’s a remarkably complex balancing act,” Yuill says.
On performance awards generally, the report notes outperformance is handsomely rewarded but, with a few exceptions, underperformance is not penalised. “It is almost as if executives are entitled to expect a reasonable performance bonus even when not warranted by performance.”
Appalling levels of disclosure explain many of the flaws in the system, but it’s also evident an absence of robust shareholder engagement is behind the poor disclosure and executive entitlement. Nick Icely, who did much of the detailed research underpinning the report, says the thinking behind the system has been shaped too much by consultants, and shareholders need to be more involved.
The report holds out some hope that King IV’s greater focus on executive pay might encourage more effective engagement on the issues. But it says although King IV provides the opportunity and platform for increased shareholder influence on pay, “there are no shareholder guidelines to enhance the legal and governance dictates and to provide an agenda against which executive pay can be discussed and its disclosure examined and voted upon”.
In the UK, the Association of British Insurers has played a guiding role, but there’s nothing similar in SA. However, given the UK situation seems even more flawed than SA’s, it’s hard to know if a collective push from local institutions would make a difference.
The report doesn’t attempt to provide answers but it gives useful direction and will raise the level of debate.