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This country has a history of company owners (albeit mostly private or privately controlled public companies) rewarding executives who have contributed to the wealth of the company, in unusual ways like no (or very low) interest loans to assist them to create capital, providing them with opportunities to buy out parts of the business at a value much below the market value. Indeed, immediately after the War there were examples of senior executives running their own businesses while working in public companies.

These things were informal ways of recognising that if a particular person had the capacity to generate great wealth, that if that capacity had to be harnessed for the good of the company, it could not necessarily be limited to what the company could afford to pay in a salary.

These things are not possible today given Fringe Benefit Tax, greater transparency in relation to the disposal of company assets and inter-company transactions. Today it’s just not on as a means of rewarding senior executives.

Beyond the legalities, the system was far from perfect, being very much at the whim of the "owner/controlling shareholder". So that nepotism was rife! Executive remuneration is much more structured today — and, at the top end, generally much higher!

Following the collapse of HIH, and the decline in value of the highly regarded AMP, much anger and frustration was directed at the highly paid executives — and not surprisingly much of this translated into anger at the sheer size of their remuneration ¹.

Roy Morgan Qualitative Research reported comments such as the following;

Today, the media is full of the debate about CEO and Senior Executives’ salaries. Like a good movie or popular series the CEO salary debate is self nourishing- it has "goodies" (those who created wealth for many) and "baddies" (those who plundered companies and walked away unscathed); and it draws upon and then feeds on Australian values of "equity" and "fair play".

Of course this is not helped by words like "obscene" and "humbug", being used in conjunction with Business Chiefs and salaries; and Senator Stephen Conroy calling Directors dinosaurs with their "snouts fairly in the trough". These do little more than inflame those least able to do anything about the situation.

Is it fair that some earn more than others, or have more, even much more, than others? Along with many Australians, I have real difficulty with this philosophical question.

But equity is not the real issue here, and it must be remembered that not all CEOs get huge salaries, and not all CEOs get huge payouts.

The real issue is much more complex. There are three types of CEO: those who create wealth; those who maintain the status quo; and those who destroy companies.

As with many things the challenge is to know which is which. Unfortunately many who think they can build companies actually destroy them.

The worldwide problem is that there are significantly fewer good CEOs than companies to run. So the best CEO candidates have many choices. They can run their own business; run someone else’s business; enter politics, retire, enter academia, or a life of crime, or engage in community or charity work.

Eric Beecher, of Text Media, just sold his business to Fairfax for some $44 million. Would he have made as much applying the same skills and experience to say running The Age, or Fairfax? Definitely not!

Every dinner table conversation that turns its wisdom to the CEO salary debate will at some point get around to "risk" — especially if any one in the group is, or has been, a business owner — regardless of how small.

"Owners take risks" will be the conventional wisdom, "for executives, there is no down-side" will be the argument. "Except" some lone voice might suggest, "they could lose their job, and there is the opportunity cost."

The real problem is of course, unless there are rewards and/or guarantees who’ll take on the tough turnaround jobs?

The fatal flaw in the market logic

Despite there being fundamental market logic in CEOs being well and competitively rewarded and compensated, there is a very real problem — double inflation, even triple inflation in the making.

Salaries are generally determined by "competitive benchmarking" — what the average CEO in a similar sized company, in a similar industry would expect - plus a bit (premium) because no one wants an "average" CEO.

The reduced length of time CEOs on average spend in their jobs, means the inflationary "plus a bit" occurs with ever-increasing frequency. This is not dissimilar to the impact that would occur from a move from compounding interest monthly to weekly then to daily.

Moreover if CEOs at all times must be market competitive, and regardless of their contract increased to keep in line with the market (as was the explanation for Coles Myer’s John Fletcher’s proposed salary increase ²), then their there exists the potential for tertiary inflation. (It is unlikely that Directors would as willingly review the rent they pay to bring it into line with the market until their lease was up!)

Concern has been expressed that "Transparency" will increase salaries (Head-hunters have a better source of information to bid up salaries in an effort to woo a CEO away) and others both in the organisation and outside make comparisons and seek increases. (The typical management wage push comes from comparisons among people leading to dissatisfaction)

Warren Buffet’s point seems particularly pertinent. " It would be a travesty if the bloated pay of recent years became a baseline for future compensation. Compensation committees should go back to the drawing board." ³

The Board? The CEO? Management? Shareholders? The Government? Typically responsibility would have been held to lie with the Board, the CEO, or Management. But the recent developments proposed to have Government and shareholder involvement in the Remuneration decision process, means that these two groups must go on the list of those potentially responsible.

And what of the exiting CEO- who is responsible? A CEO exiting early, and getting a big payout, when a company is not performing (which is what everyone is upset about) is a failure of some kind.

Is the CEO responsible - he or she did not perform? Is the Board responsible - they hired the wrong person; they did not provide the right environment, support, or direction for the CEO to be successful?

Much has been written about CEO salaries — but less attention has been directed to the role of the Board — either as the problem (or part thereof) or as the solution.

The Board’s job is to hire and/or fire the Chief Executive — and decide on the remuneration- packages, strategies, incentives, etc aligned to the directions set for the company by the Board (their other duty)

As one Company Director surveyed pointed out ⁴, " Many Directors don’t know what their company does." "Directors must understand the industry, the business and the issues"

Australians don’t want a figurehead for their Governor General, and they don’t want figureheads as Directors of their companies. Yet many, perhaps most, leave the crucial process of CEO selection and remuneration to "recruitment specialists" or "head-hunters".

How many "head-hunters" have been valued members of Boards of major companies going through dramatic change or have been a CEO who has successfully turned around a failing company? Very few, if any!

We all nod when confronted with the old adage that " Those who can’t do, teach", but what about the Board’s critical role of selecting the right people for the top of the company?

Back to the drawing board

Warren Buffet challenges Directors to go back to the drawing Board. When it comes to CEO or Senior Executive recruitment and remuneration, the Board can do it differently, not just follow suit. Remember the saying of the 1980’s to the effect that nobody ever got sacked for buying IBM! Yet those corporations in the 1980’s who switched to networked computer solutions were able to transform their businesses, and make millions.

In selecting and employing a CEO, just like a new plant, a new business, a new building, the Board must look for value. There is a need to look at alternatives- would two smaller plants actually be better than one, would some kind of "virtual office" have relevance?

Would a well-planned team of 5 people each on say 30% of the CEOs salary be better than a CEO plus 4 people on 20% of his or her salary? This represents not only a 30% saving, but also a break in tradition- empowerment of a team (we believe in teams at lower levels- and seek "team players", and "partnerships of equals" at Board level, but cling to the notion of the sole CEO -godlike at the top). And remember the one who was second in line often becomes CEO — either at the same company or another.

Rotating CEOs may actually achieve the kind of rejuvenation that seems to be needed — or is thought to be needed - every four years or so.

This happens in Legal Partnerships (many of which are very large businesses and extremely profitable), it happens with "Head of Department" at Universities, and has been used in situations where Advertising Agency acquisitions have resulted in the individual companies retaining their existing structure. (The Head job rotates).

Alternatively, rather than a forced rotation, there could be a decision as who would be CEO from the team depending upon the Strategic direction set for the Company by the Board.

The Board would have a larger role in setting the direction of the Company, and thus the particular person in the CEO role.For instance a marketing focussed CEO will bring a certain approach — and would be an obvious appointment if the Board determined the corporate direction for the next 3 years will be on growth through sales and commercialisation of existing products.

On the other hand if the Board has set the direction as one of fundraising or acquisitions to increase size, a different CEO from the group may be appointed.

I raise these ideas not as prescriptive solutions, but as a means to stimulate thinking about alternatives

"The job of employing a CEO must be done well, and be seen to be done well".

Others in the organisation, who hire staff, have to articulate and rationalise the salaries they pay.

A CEO is in many ways like any other investment - a building, a company, a new computer system. The strategy and tactics involved in these three examples are not dissimilar to those involved in finding and employing the right CEO at the right price — and these transactions are open to scrutiny..

The closest to choosing a CEO is probably buying a company, or doing a merger where issues of price, cultural fit, and future earnings are all important.

I have never seen a deal where the recently acquired company was subject to a special arrangement such that if the cultures did not fit, the company would be given back, and paid for the experience. (In hind-sight such a deal may have been fairer than some that occurred in the height of the dot.com boom eg Time Warner and AOL).

Shareholders would be distressed to find out after the event that such a deal had been done.

I’m reminded of the tale of the Creative Director in the old days when group discussions and one-way mirrors were used to test ads, and his frustration over having housewives tell agencies how to create ads. He tells of having his self-restraint strained to the limit as a party of housewives tore his concepts to shreds, and suggested their own.

" But when they begin to see merit in Lavinia’s jingle that simply chants the brand name incessantly, any creative person (who’s any good) finally has to be physically restrained" ⁵

Encouraging shareholders to vote on Executive’s salaries must not be allowed to degenerate to that!

In advertising today "the Worm" reports how people respond to the advertising. In companies the share price is the equivalent of "the Worm". It should respond, not dictate.

Shareholders are not a "quasi-Senate", and the ramifications should they take that role would be far reaching. There would be not only a fundamental shift of power, but also a fundamental shift in responsibility.

Today debate rages on the proposed Senate Reform - whether the Senate is a legitimate check on the Government of the day, or whether the Government of the day has a right to govern without "obstruction". Prima-facie there are strong parallels in relation to the roles of Boards vis-à-vis shareholders. However, there is a very fundamental difference — shareholders can sell at any time. The share-price is a real time measure of the confidence in the company and the Board — one which translates immediately into $s. Whereas the Government of the day is judged only by the polls which in reality represent little more than a warm (or cool) feeling except on Election Day.

The role of Company Directors in this Executive Remuneration debate is essentially one of opening the communication channel. The questions are: Are you as Board Members communicating with your shareholders, in such a way that they can understand what you are doing? Have you put your strategies into a broader context for your shareholders and stakeholders? Have you involved them? Have you been transparent about the complexities? Are you communicating honestly, intelligently and with wisdom, or just giving the "company line"?

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© 2007 Roy Morgan Research. All Rights Reserved
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