EXECUTIVE REMUNERATION TIME TO GET POSITIVE To the Editor

  • Date:01 Jul 2005
  • Type:CompanyDirectorMagazine
A recent piece by Fiona Buffini (Australian Financial Review "Stock options bonanza", 19 May), refers to research by institutional adviser Proxy Australia that CEOs are enjoying windfall gains on their stock options, far above the value disclosed to shareholders.

EXECUTIVE REMUNERATION: TIME TO GET POSITIVE

A recent piece by Fiona Buffini (Australian Financial Review "Stock options bonanza", 19 May), refers to research by institutional adviser Proxy Australia that CEOs are enjoying windfall gains on their stock options, far above the value disclosed to shareholders.

According to Buffini, the study has prompted shareholder calls for greater disclosure of executive remuneration arrangements to include option gains and valuation methods.

Internationally, executive remuneration has become the most important and contentious aspect of contemporary corporate governance. As US legal scholar Ima Anabtawi has recently written: "Few recent issues ... have drawn more ire from the public or more bewilderment from scholars than the compensation of public company CEOs". What has been of particular concern is the "decoupling" of executive pay from company performance. That is, CEO pay packets continue to skyrocket, while the companies they manage enjoy modest growth, no growth, or negative growth.

In Pay without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press, 2004), prominent US law professors Lucian Bebchuk and Jesse Fried point out that in their country, between 1991 and 2003, the average large-company CEO's total remuneration increased from 140 times the pay of an average worker to 500 times average pay. Similarly, in Australia, between 1992 and 2002 CEO remuneration increased from 22 times average weekly earnings, to 74 times.

Pay without Performance has produced a deal of debate concerning executive compensation, particularly in relation to the "managerial power" thesis put forward by Bebchuk and Fried to explain the decoupling of pay from performance that we have witnessed. Under their thesis, senior executives are considered to be overwhelmingly motivated and guided by their own self-interest, with their self-interest directly connected to their pay packet. These self-interested executives are considered to have enormous influence over the board of directors who determine executive pay, and therefore structure remuneration arrangements with the interests of the CEO as the primary concern.

Bebchuk and Fried do not in any way question the legitimacy of using "pay for performance" as the principal methodology for determining executive pay, and indeed contend that appealing to the hip pocket of executives is the best way to motivate executives to perform and to satisfy their personal objectives. Pay executives as much as they can possibly dream of, they contend, so long as there is a correlation between higher pay and improved company performance.

In The False Promise of Pay for Performance: Embracing a Positive Model of the Company Executive, to be released next month, I respond to the "managerial power" thesis - in particular the very negative model of the company executive that they put forward.

I draw upon an extensive amount of literature from a wide range of literature (including psychology, sociology, and the emerging science of happiness), to explain why the emphasis on remuneration and "pay for performance" is misguided.

This literature makes it very clear that the overriding motivation of executives in terms of their relationship with the company is not the promise of high salaries and lucrative options packages, but rather the desire to do a good and be part of a successful and respectable company.

Furthermore, rather than more and more money being the key to greater and long-lasting happiness, studies in the emerging science of happiness suggest otherwise. It is not money per se that makes people happy, but rather the enhancement of one's "relative position" (ie being objectively more successful than one's neighbour or colleague), which comes from a high income and a luxurious lifestyle, that explains our drive for material wealth.

As I explain in the book, based on this emerging literature on real human motivation and behaviour, it is time for a fundamental change in our approach to executive remuneration in particular (and corporate governance in general).

Rather than waiting for the promise of "pay for performance" to deliver, and continuing to focus on "improving" disclosure requirements for remuneration arrangements that generally do not work, it is time to embrace a positive model of the company executive. The evidence on executive motivation and the natural competitive instinct of executives can be used in more productive ways.

Adopting this positive approach to corporate governance, the emphasis would be less on being able to say "my options are bigger than yours", instead turning to being able to say "my company is more respected/ bigger/ has happier employees/ better products than yours". This is surely better for shareholders and executives.

James McConvill

Lecturer at Deakin

Law School, Melbourne,

and principal of The

Corporate Research Group

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