Inflated executiv ve pay
T “HE POINT IS, ladies and gentlemen, that greed – for lack of a better word – is good,” intoned Michael Douglas as Gordon Gekko in Oliver Stone’s 1987 Wall Street. “Greed is right. Greed works. Greed clarifies, cuts through and captures the essence of the evolutionary spirit. Greed in all of its forms – greed for life, for money, for love, knowledge – has marked the upward surge of mankind. And greed – you mark my words – will not only save Teldar Paper but that other malfunctioning corporation called the United States.”
Some 21 years later movie studio Fox has confirmed the sequel: Money Never Sleeps is making progress. The credible movie industry journal Variety has reported the sequel is being fast-tracked – ironically – to capitalise on the renewed relevance of the stock market on the lives of ordinary people. Greed, it would appear, remains paramount.
Producers will want to strike while the outrage at executive remuneration and golden parachutes for those who created the current financial crisis is fresh in the minds of the viewing public. The theme of corporate greed is universal. Executive pay is a highly emotive issue. Since JSE rules made disclosure compulsory in 2002, pay consultants say it’s had the effect of driving up remuneration because managers have been able to present factual evidence of competitors’ pay.
Wall Street developed a cult following and won Michael Douglas an Oscar. Its subject matter at the time meant it didn’t draw massive box office revenues: producers suspect its sequel will now strike a stronger chord as business and investment issues have become more mainstream than they once were.
The current world financial credit crisis is unlikely to spell the end of the stereotypical corporate fat cat. However, it will lead to a tougher global regulatory environment, will raise levels of shareholder activism and lead to demands of greater executive accountability.
Regulators, investors and consumers will for the time being at least remain super-vigilant.
In his acceptance speech in Chicago after last week’s election victory, US president elect Barack Obama hinted at changes to come. “If this financial crisis has taught us something, it’s that we can’t have a thriving Wall Street when Main Street is suffering.”
The reality is that few complained while the going was good. Shareholders benefited from the superlative returns delivered by a new breed of executives who appeared to have a far better handle on financial markets than their predecessors. Now that the fiction of superior management has been exposed, shareholders are up in arms.
Though a revolution in the way in which executive remuneration is calculated is unlikely, an evolution is certainly under way, with moves afoot worldwide to restrain the levels of greed that have consumed markets for the better part of this century.
Domestically, new proposals contained in working documents ahead of the release of King III suggest Corporate SA is likely to see the most radical review in executive pay since 2002. The new measures under discussion are far-reaching and, if implemented, will require more prudence by boards, higher levels of disclosure and greater accountability than ever before. It’s unlikely executives and nonexecutive directors are going to like the new guidelines very much: it’s unlikely to hurt their back pockets much either.
The issues are being debated at the Institute of Directors (IOD) in the run-up to the publication of King III early next year. They’re aimed at forcing remuneration committees to ask the perennially elusive question: What is an executive actually worth?
The arguments for generous executive pay can be compelling – especially in a South African context, where senior management skills are in short supply. Jim Steer, manager of Job Evaluation Products at Deloitte, says 59% of companies have implemented executive retention strategies, while 30% have over the past year struggled to recruit new executives, up from 23% the year before.
However, it remains a highly emotive issue. Remuneration is a function of supply and demand. The fewer qualified and suitable candidates there are for a particular job, the higher the likely compensation.
Share options have elevated SA’s top bank managers, builders and shopkeepers into the ranks of the super wealthy. There’s constant debate on whether the packages granted to some of this country’s best and brightest business talent through an unprecedented bull market were justified.
Among the best-paid executives at companies with SA listings are those with international operations and foreign listings. Excluding options, bosses such as SABMiller CEO Graham McKay and Investec’s Stephen Koseff rank among the super-remunerated, earning more than R50m/year. Despite the fact they run banking operations overseeing considerably larger customer and asset bases, CEOs of SA financial sector firms are less well paid. Steve Booysen at Absa and Jacko Maree at Standard Bank each earned more than R18m last year.
The average global pay gap between senior executives and ordinary workers is around 100
times. In SA, in intermediate to large companies the gap between minimum wage earners and the CEO is 58 times. In 1994 the wage gap was a more muted 37 times, according to PE Corporate Services.
The drafting of King III comes as new research shows that SA’s executives are among the world’s best remunerated and enjoy higher living standards and more disposable income than most of their peers in Europe, Australia and Africa. Research involving more than 850 companies, conducted by PE Corporate Services, showed only executives in Germany and the US eclipse the lifestyle of bosses in SA.
While executives in SA may enjoy some of the highest standards of living in the world, this country slipped from 29th to 36th in the Hay Group’s World Pay Report issued in September. While pay packages remained globally competitive, the effect of high domestic inflation and low economic growth eroded some of the prosperity while previous underperformers from oil-rich states surged to the top of the performance tables. Key new proposals being debated at the IOD include the following: company’s top five earners, not just executive and non-executive directors. ance targets to enable shareholders to establish whether those are being met. tion and not be a rubber-stamping authority after the fact.
share options. vidual performance measures; however, meeting fees will be maintained.
“Current trends suggest executive pay in SA is likely to increase,” says Lindie Engelbrecht, CE of the IOD. That’s primarily due to SA’s skills shortage, fuelled still further in recent months by political uncertainty, a lack of security about basic services, such as power generation, and spiralling crime rates. “Emigration is one of the biggest threats companies face,” says Engelbrecht.
According to new research by professional services group Deloitte, the average executive turnover for the year to 31 July 2008 was around 13,4%, up from 10,5% in 2007. By far the most significant reason for executive departure last year was retirement: 22% of executives who left formal employment retired. However, an alarming 15% quit due to their desire to emigrate: 60% of them said their primary reason for leaving the country was its high crime rate.
SA companies face increasingly serious challenges when it comes to executive retention. High levels of emigration show top talent is highly mobile. In recent months a large number of senior executives have packed their bags seeking greener pastures. Among them: Truworths financial director Wayne van der Merwe, Builders’ Warehouse MD Aubrey Cimring, Sasfin MD Alan Greenstein and Peregrine CEO Keith Betty. Australia has replaced Britain as the most popular destination for mobile executives, with 31% of respondents citing it as their country of choice.
Many executives are also quitting – simply because they can afford to do so. The bull market of the five years to end-2007 and its
associated generous performance-linked bonus and option schemes have enabled greater numbers of executives to step back from the corporate coalface better off than at any other time in SA’s history.
The Mabili Rewards 2008 Directors’ Remuneration report showed 23 CEOs resigned in the year under review, nearly double the number in the 2007 report and considerably up on 2005, when just two bosses of listed companies quit. Among those who went last year were AngloGold Ashanti CEO Bobby Godsell, Anglo American boss Tony Trahar, Anglo Platinum CEO Ralph Havenstein, Tony Phillips of Barloworld and Mark Lamberti of Massmart.
Martin Westcott, MD of PE Corporate Services, says the financial position of South African executives has improved materially over the past decade due to a significant domestic skills shortage and a controversial global explosion in executive pay.
Pay is controversial, as remuneration committees are seldom made up of industry or performance specialists. In many cases members of remuneration committees may serve in a similar capacity in a number of companies.
The reality, says Laurence Grubb, MD of Mabili Rewards, a firm that consults to boards on remuneration, is that executives themselves play a key role in driving the pay agenda. Boards will often task directors to appoint consultants to advise on pay, proposals are then formulated and presented to remuneration committees. Few are rejected or redrawn. Grubb says it’s an area where the integrity of consultants and executives is tested with varying degrees of success. “Boards are increasingly mindful of public criticism and media scrutiny,” says Grubb, pointing out there’s a growing realisation that boards aren’t only accountable for remuneration but also to ensure that shareholders receive value for money.
Performance, argues the IOD’s Engelbrecht, shouldn’t only be based on profits – there should be more of a holistic view, with issues such as staff retention, internal controls, stakeholder communication and sustainability all part of the equation. Companies also need to look at how that performance is assessed. By disclosing performance targets and detailing remuneration methodology, shareholders will be better equipped to act as watchdogs at firms where boards don’t adequately manage the pay process.
One of the most radical proposals affecting directors is that boards will, under King III, be expected to spell out their remuneration strategies and clearly disclose performance targets, not only for CEOs but also throughout senior management. That will enable shareholders to decide whether or not those key targets have been achieved and avoid situations such as that which occurred at Eskom, where the public corporation’s remuneration committee offered incentive payments to directors despite this January’s blackouts – due to the fact that provision of electricity wasn’t one of the group’s performance measures.
“Performance incentives tend to be short term in nature,” cautions Engelbrecht, pointing to a need for executive fortunes to be linked to longer-term company performance.
That’s easier said than done, especially with signs of an economic slowdown emerging. In his medium-term Budget policy statement, Finance Minister Trevor Manuel downgraded his 4% growth target to 3,7% for 2008 and 3% for 2009, indicating clearly that SA won’t escape the consequences of a global slowdown. Recent research by Sake 24 and BoE showed a rapid slowdown in SA’s private sector. In particular, economic activity in the country’s economic heartland – Gauteng – has slowed dramatically.
The index, devised by T-Sec chief economist Mike Schüssler, showed a 16% decline – by far the biggest decline of any province. “The financial services, property and business services sectors, in particular – as well as certain individual industries, such as the vehicle industry – are already in recession,” says Schüssler. “That will spill over into the broad retail and wholesale sectors and later into manufacturing.”
“We recently conducted a snap survey of selected clients. Six months ago many were forecasting across the board increases of 12% in 2009. Many have now downgraded that to single digit increases on guaranteed pay,” says Moyra Vermeulen, at Deloitte, who also points to the fact growing numbers of bonuses will be missed as targets aren’t met.
In tough economic times, companies need to find ways to retain top talent as many long-term incentives are under water. Bonus structures are also going to come under pressure as profits decline and targets aren’t met. It’s a perfect time to poach talented individuals from firms where options are declining and bonus payments are less than secure.
“We’re going to start seeing a reduction in reported bonuses in annual reports from now on,” says Mabili’s Grubb. “What’s going to be interesting is to see whether there’s any correlation between company performance and a reduction in bonuses. It’s the first time since compulsory disclosure has been introduced that the systems are going to be tested.”
It’s already happening. Woolworths’ 2008 annual report disclosed CEO Simon Susman has seen his pay fall 15% as profits at the highend retailer took strain. Last week it emerged the two executive directors on FirstRand’s board – Paul Harris and Sizwe Nxasana – have also been forced to accept small pay cuts after the group reported its first earnings decline in its 10-year history in the year to end-June. Harris took home R15,4m, R1,053m less than in 2007; Nxasana saw his overall remuneration cut by R585 000 to R12,484m.
While some emotive responses to corporate excess are demanding punitive measures for failed executives, there’s no chance that will happen.
Managers will simply opt to work elsewhere. The only risk executives face is losing their bonuses or their positions. For most the risk of reputation damage is the biggest threat they face.
Remuneration systems are constantly evolving. The latest trends developing in Britain include measuring performance in absolute terms, where issues such as economic growth and inflation are taken into account, as well as relative performance to ensure executives do better than their peer group before juicy bonuses are doled out.
Pay remains a thorny issue. With greater scrutiny than ever before, boards are focusing on the design of remuneration systems. The watchdogs are eager to see what impact it will have, not only on pay but also on disclosure and executive performance.