Finance Finance News Ripping apart the ‘myths’ that justify huge CEO pay

Ripping apart the ‘myths’ that justify huge CEO pay

ahmed fahour
A Senate committee has revealed Ahmed Fahour's million-dollar salary package. Photo: AAP
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The revelation that Australia Post CEO Ahmed Fahour is being paid $5.6 million a year has sparked fresh outrage over corporate greed, as experts refute the theories used to justify huge executive salaries like these.

On Tuesday night, a Senate committee forced Australia’s government-owned postal service to reveal that Mr Fahour was paid $4.4 million in salary and $1.2 million in bonuses last financial year, eliciting the disapproval of even the Prime Minister, who called it “too high”.

Australia Post had argued that revealing the salaries of Mr Fahour and other executives could hurt the company.

Professor Peter Swan, finance expert at the University of New South Wales, said the real problem is not the isolated example of Australia Post, but the broader issue of executive pay in the corporate world – pushed ever upwards by an “utterly absurd” demand for “so-called” independent directors.

A tenth of directors at Australia’s top 200 companies own no shares at all in the companies they oversaw in 2015, while others had very low stakes, according to the Australian Council of Superannuation Investors (ACSI).

“Since these independent directors are not allowed to have significant share ownership in the company, they are approving the pay of CEOs and other executives out of someone else’s money, not their own, and thus have far less oversight over pay than they should,” Professor Swan told The New Daily.

He proved this in a 2016 study, which found that company performance and investment decision-making worsened, while executive pay increased, the more ‘independent’ directors a board had.

“In privately-held and family-controlled large international businesses, we find much lower levels of pay, and where there is a substantial shareholder on the board, especially on the audit committee, once again we see much lower levels of pay and much better levels of performance.”

Another popular theory, called ‘managerial power’, says CEOs use their personal influence over sympathetic corporate boards to boost their pay.

Dr Andy Schmulow, a corporate regulation expert at the University of Western Australia, blamed directors for relying on the “fig leaf” of supposedly independent advice.

At most companies, a remuneration committee appointed by the board of directors sets CEO pay based on the advice of external remuneration consultants.

“If you want to be a successful remuneration consultant, you have to recommend that salaries go up as much as is humanly possible without causing a shareholder backlash,” Dr Schmulow told The New Daily.

Whatever the cause, executive pay has skyrocketed.

Between 2001 and 2008, median fixed pay for Australian CEOs rose a staggering 120 per cent, from about $780,000 to $1.7 million, ACSI found.

Last year, median pay for CEOs at Australia’s top 100 companies fell -2 per cent in 2015 to $3.8 million, but this was more than made up for by a 5.8 per cent rise in median bonuses to $1.6 million.

The ‘myth’ of the super-talented CEO

The argument used most often to defend exorbitant CEO pay is that talent is both rare and indispensable and must be lured by large pay cheques.

Tim Cook
Can we really attribute the success or failure of Apple to Tim Cook? One expert says no. Photo: Getty

But in his 2014 book Indispensable and Other Myths, US corporate law expert Professor Michael Dorff used the latest academic research to argue that the addition of performance-based incentives (stock options and bonuses) to “already-generous” CEO salaries since the 1970s has not and cannot improve company performance.

Not only do senior executives have little impact on a company’s stock market value, but performance-based pay can actually erode motivation and sap executives of creativity, analytical reasoning and innovation, causing them to manage companies with a risk-averse and overly short-term view, he wrote.

“The current cult of leadership and lottery-type compensation packages that can result in generational wealth foster precisely the wrong sort of culture for CEOs, one that encourages them to put their own interests first and the company’s last.”

‘Follow Germany and the Nordic countries’

To moderate executive pay and improve company performance, Professor Swan said Australia should follow the Nordic example by creating a “more shareholder-focussed governance system”.

german workers
In a firm with more than 2000 employees, German workers get to elect half of the board (with some exceptions). Photo: Getty

“In the Nordic countries, major shareholders have a much larger say in the remuneration and board appointments, and that could be very easily brought in in Australia.”

Dr Schmulow said we should follow the German policy of ‘Mitbestimmung’, which allows workers at large public and private companies to elect a number of directors.

After last year’s BHS scandal, UK Prime Minister Theresa May proposed to “reform capitalism” by putting workers on company boards, like Germany, and to make shareholder votes on remuneration legally binding.

She has since backed away from the worker idea, but seems committed to binding remuneration votes.

Professor Dorff wrote that shareholder votes on executive pay should be made binding rather than advisory, and that large shareholders should be represented on remuneration committees.

In Australia, under the ‘two strikes’ rule introduced in 2011, investors can trigger a board spill if 25 per cent or more of a company’s shares are voted against two consecutive remuneration reports.

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