In­flated ex­ec­u­tiv ve pay

Finweek English Edition - - Cover -

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.

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