The remuneration game

The upcoming reporting season means the issue of executive pay will once again be on the table. Kath Walters sees a way to cut executive pay by 30 per cent and still get the best in the world.

We are coming up to reporting season, and the issue of executive pay will again be on the agenda. And so it should be. Compared to most countries in the world, Australians are very generous about how much chief executive officers (CEOs) should be paid compared to average earnings. A recent study showed that we are willing to give our CEOs 8.3 times what an unskilled worker gets. The rest of the world reckons 4.6 times is about right.

So, what do CEOs get paid compared to the rest of us? In 2013, CEOs received 63 times average earnings, and that was a fall from the 94 times average earnings they were receiving in the years before the global financial crisis. CEOs do not deserve the money they are paid, in the eyes of the community.Of course, boards see the problem of executive remuneration from a very different perspective. Executives in our top companies are part of a global marketplace. If remuneration in Australia falls behind global standards, Australia’s companies will not attract the best leaders. Many boards have responded to the complexity and risk of the executive pay debate by employing consultants, some costing over $200,000 for their advice. What are boards to do?

On 24 June, the ASX announced changes to the pay of its managing director and CEO, Elmer Funke Kupper MAICD. The board has changed the amount of cash that Kupper receives relative to short-term incentives (STIs) and long-term incentives (LTIs). The ASX wants to set an example to other Australian companies. Laudable as the ASX’s leadership might be, it fails in my view on two counts. One, it is tinkering at the edges – the new package is not lowering the overall amount that Kupper is paid, thereby delivering a saving to shareholders. Instead, it is deferring cash payment of incentives and putting more of Kupper’s remuneration (60 per cent) “at risk”.

This means that if Kupper fails to meet his targets, he will be paid less, but returns to shareholders would also fall. Secondly, deferred incentives are not very effective. A 2012 survey and report by the accounting firm, PwC, showed that executives worldwide are risk averse when it comes to remuneration. And Australian executives are slightly more conservative on the subject than their global peers.

PwC’s report findings were based on a study involving 1,106 executives in 43 countries. The study explored the trade-offs that individuals make between risk, reward, certainty and time. What it showed is that the value of LTIs is greatly discounted in the minds of executives. Money now is worth more to them than money that may or may not appear in the future.

Here’s why: executives are risk averse. Only 28 per cent were prepared to swap the certainty of receiving $41,250 for a bonus of $90,000. Given the choice, almost every participant selected the less complicated option. Most LTI plans are complicated; unnecessarily complicated systems are unlikely to produce the best results. The longer you have to wait, the less it’s worth. When executives have to wait for rewards, they discount their value in their own minds. The study found this was quite a specific number – 30 per cent for every year the reward is deferred.

Actually, all that matters is what your mate gets paid. In the end, people really just want to be paid the same as their peers. With one important exception: job satisfaction.

The report found that participants on average were willing to accept a 24 per cent pay cut for their “dream job”. Australian executives were slightly higher than the global average – they would accept a cut of 30 per cent.

“Investment in making people’s jobs more interesting and fulfilling means you can pay them significantly less,” the report explains. This finding puts a lot of power back into the hands of boards. Firstly, the issue of LTIs needs careful assessment. Although most leaders will agree to LTIs, in most cases, they do not offer value for money. Secondly, the idea of improving job satisfaction for our leaders deserves more exploration, particularly by boards, whose decisions can have an enormous impact. 

Rather than offering our executives the best pay in the world, boards might start working on how to offer them the best jobs in the world. That way, we might see a real trend towards lower compensation overall, and lots more happy, creative and inspiring leaders.