Thursday 5th October 2000
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But three separate studies now suggest it's not just executives getting a bad deal. Shareholders look like far greater victims, say the studies, thanks to our executives not so much being "badly paid", as being "paid badly". You'd think, for instance, that chief executives' salaries would be tied to company performance, right? Wrong.
The studies show no correlation between chief executive pay and performance. In fact, they show that bosses of big companies earn more than bosses of small ones, regardless of how well the company is doing. They also show incentive compensation schemes - stock options and the like - have little or no effect on corporate performance. Most worrying, one of the reports suggests that some of the companies paying their executives the most are the most adept at destroying shareholder wealth.
This last result comes out of what's emerging as something akin to a Department for Shareholder Misery, at ANZ Investment Bank. The bank's research unit has been producing a series of analyses using the Economic Value Added (EVA) measure of company performance. Its most notorious finding last year was that New Zealand's top corporates have collectively destroyed $15 billion of shareholder funds in the past nine years. Its latest report ("Corporate New Zealand shareholder value report", July - Oct-ober 2000) shows that, at best, a chief executive's salary bears no relation to a company's EVA performance, only to its size. At worst (in three cases), big falls in EVA coincided with large salary increases (see "Pay and performance" chart on page 28).
"In those cases, the salary increases result from an increase in size of company, not increases in share performance," says the report's author, Joseph Healy, who argues there is an unacceptable gap between pay and performance in New Zealand companies. "It happens to degrees in other countries, but it's not as endemic as it is here. When it happens overseas, the press and the shareholders hold executives to account for their performance. Here, there's a lack of financial sophistication."
Big firm, big pay
Healy's work is backed by two new academic studies. The first1, a study of 50 listed firms by Otago University finance professor Glenn Boyle, found no significant relationship between chief executives' pay and the stock market performance of their firms. Instead, results show the pay relates merely to the size of the firm and the size of its sales: the bigger the company, the bigger the salary. Boyle deliberately uses historical data - board performance 1991-1996 and CEO pay in 1997 - to establish what the situation was when compulsory reporting of CEO pay was introduced in 1997 (see table below). The scary thing is Healy's research shows nothing has changed since. Boyle also discovered board size functions the same way: bigger companies have bigger boards. He suggests big boards, which he argues can be bad for full and frank discussion and for individual director accountability, can be more easily dominated by the chief executive and his/her wage demands. If that's right, then some chief executives have captured their boards and are milking them for high remuneration.
Boyle also turned his attention to the relationship between company performance and the proportion of shares owned by directors. Here again, he finds no correlation. Which brings us to the fascinating question of whether a stock entitlement affects the relationship between pay and performance. This topic is particularly interesting because new e-businesses usually give employees a bunch of stock options. The idea is employees will work their guts out if they have a stake in the company and will get rewards if their efforts increase the stock price.
Boyle found only "weak evidence" for this connection. In fact he discovered "firms which do not offer an option entitlement scheme exhibit a stronger link between chief executive pay and medium-term performance than those that do".
Boyle isn't alone in his conclusions.
The second paper2, written by three members of Massey University's commerce department, examined criteria including rate of return on equity and rate of return on assets for 50 NZSE companies between 1994 and 1998. Chief executive pay ranged from $55,000 to $1.6 million.
The results (sorry if this sounds like a stuck record) are that companies which paid more to their top executive did not outperform companies that paid less well. And that pay is significantly associated with company size and business risk. Chief executives working for companies classed as having greater business risk enjoyed packages worth a mean value of $460,000, while chief executives in less risky businesses earned an average of $235,000.
The Massey study also failed to find any link between incentive compensation schemes (normally in the form of shares or share options) and better corporate performance. Chief executives in companies with an incentive scheme also get higher pay, but a scheme has "no significant effect upon corporate performance".
It's not the same in the US and the UK where studies indicate either "significant increases in the pay-performance link" and/or "shareholder share options being strongly and significantly associated to shareholder returns". Boyle, by the way, records the same thing about the US and UK.
So what's the difference between New Zealand and the others? The Massey researchers are unequivocal. New Zealand has a weak regulatory climate, allowing directors more freedom and less accountability than their overseas counterparts. And because of our shortage of talented directors, some people are directors on quite a few boards and may be over-committed and disinclined to rock the boat. Put these people on remuneration committees, deciding chief executive compensation, and they may be too pliable.
Healy agrees. "We are unlikely to move ahead until boards are willing and able to take the lead in paying and defending stronger performance-based compensation."
In other words, shareholders wake up! Boards aren't doing their jobs properly.
Neville Bennett, Nikki Mandow
1 "Public exposure of executive compensation: do shareholders need to know?" by Glenn Boyle and Warren McNoe (Otago University), and Aleksander Andjekoric of Global Telematics, July 2000
2 "Executive incentive compensation schemes and their impact on corporate performance: evidence from New Zealand since legal disclosure requirements became effective", Fayez Elayan, Jammy Lau, Thomas Meyer, Department of Commerce, Massey University, Albany, August 2000
|5 year return ranking 1991-1996 (out of 50)||Company||CEO salary $ (1997)||CEO salary ranking (out of 50)|
|4||Steel & Tube||333,000||18|
|7||Milburn New Zealand Cement||387,000||13|
|20||Fisher & Paykel||573,000||7|
|22||Air New Zealand||1,056,000||3|
|25||Wilson & Horton||406,000||11|
|26||Carter Holt Harvey||577,000||6|
Source: Otago University
In January one lone shareholder challenged Contact Energy's proposal to hike fees. Although the board resisted, the helmeted protestor won on a technicality. Fees have stayed the same since.
In March Tower's shareholders tried to block a 50% rise in fees but lost when the board marshalled its proxies. However, small shareholders did succeed at stopping Capital Properties directors' raising fees by 25% in July. The increase was proposed on the slender basis that the company had just absorbed another, Shortland Properties.
In July Fisher & Paykel was forced to abandon a proposal to sell 110,000 shares at bargain prices to four executive directors. Significantly, it was institutional investors who took the lead. That's good news for minority shareholders, frequently too shy to demand better performance. Still, it could be worse. In Japan some boards have resorted to hiring yakuza (mafia) to ensure the orderly operation of annual meetings. Funnily enough, Japanese AGMs run very smoothly.
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