How best to put dollar value on the person who leads your organisation is one of those issues currently earning attention for all the wrong reasons.
That’s because recent corporate history in both the United States and Australia has thrown up some high profile examples of CEOs being handsomely rewarded after managing to shrink shareholder value in the companies they led.
It didn’t help that payouts such as the jaw-dropping A$33 million that went to former Colonial First State chief Chris Cuffe, the more modest A$19 million awarded to former BHP chief Paul Anderson and the almost paltry A$1.4 million that went to former AMP chief Paul Batchelor, generally arrived as an aftershock.
Shareholders have been understandably irked not just by the disparity between pay and performance but also that such salary package details didn’t emerge until the CEO had left the company.
This has prompted moves toward greater disclosure of senior executive and director remuneration and law changes that give shareholders greater say on pay. The new corporate governance environment will undoubtedly see shareholders taking closer interest in the way boards negotiate CEO remuneration contracts – and whether these include performance-based clauses to help protect shareholder value.
The multimillion dollar pay packages earned by global corporate high-fliers have come under question from various directions. Some studies suggest their level has less to do with market signals (value placed on limited commodity) than social ones (eg, status of candidate, salary expectations of the board’s remuneration committee). Other research has discovered only very weak relationship between CEO remuneration levels and organisational performance.
CEO remuneration is inevitably juggling act that involves coming up with package that attracts top talent while ensuring shareholders actually gain some value from the money spent.
It seems New Zealand companies have problem on both counts.
In overall salary package worth, local corporate heads are already lagging behind their offshore colleagues – and the trans-Tasman gap is widening, according to recent Sheffield survey involving 511 CEOs.
Comparing the most stable CEO group (those heading organisations with revenues less than $200 million) in Australia and New Zealand, it found they are shifting apart at rate of around three percent year.
For example, in 2000, Australian CEOs received fixed package 40 percent higher (in NZD) than local equivalents; by 2001 that had moved to 43 percent and in the most recent survey to 46 percent.
“That widening gap is cause for concern given New Zealand competes with its nearest neighbour for CEO talent,” says Sheffield’s head of reward consulting Stephen Richardson.
Relying on the good old Kiwi lifestyle to pull in potential winners is not really starter – particularly in work climate that is increasingly demanding of participants’ time, he notes.
“There’s bit of fallacy here that the New Zealand lifestyle is so great, people will forgo international opportunities to come here and stay here – but that’s less the case than maybe it used to be.”
Yes, it’s beautiful country, property is more affordable and the work environment less cut-throat than elsewhere but, says Richardson, we demand as much if not more in terms of work commitment than neighbours who pay more. lifestyle attractant soon fades if there’s little time to enjoy it.
But just offering more dosh is not in itself an answer – especially if it fails to deliver shareholder value. What’s needed is some linkage between payment and performance and again the survey reveals that this is an area in which New Zealand lags behind other countries.
“In North America, up to 60 percent of the pay package is performance related; in Australia that figure is typically around 46 percent. Here it’s 16-18 percent. That means CEOs are getting quite big fixed-rate salaries irrespective of the job they do.
“Many New Zealand CEOs with poor records of growing wealth or generating high performance organisations are paid the same as those that have generated significant wealth,” says Richardson.
He says the survey has three-fold message.
“Firstly New Zealand needs to be bit more competitive in how they reward CEOs. Secondly, the answer is not just for boards to give CEOs more money but to structure package that has larger at-risk component. To make this work, the third thing is the need to design schemes that pay out in the best interests of shareholders and companies, not the best interests of CEOs.”
In other words, go for long-term incentive payments rather than short-term bonuses. At present the typical CEO package in New Zealand is dominated by base salary and benefits (accounting for 84 percent of the total) with 16 percent performance pay, 12 percent of which is short-term bonuses.
The problem with short-term incentive plans is that they may drive CEO behaviour that is destructive to longer-term shareholders interests, says Richardson.
“For example, cutting costs increases profitability on paper but takes out long-term infrastructure that could leave the company struggling couple of years down the track.”
Long-term incentive (LTI) plans are designed to align the interests of CEO and shareholders, balance short-term goals with long-term growth, and aid retention by providing an opportunity for long-term wealth accumulation linked to period of service. “There are number of ways this can be done so that benefits are staggered, starting after three years in service,” says Richardson. “Where performance pay incentive schemes fail is where they are more tied to CEO best interests than those of the organisation or shareholders. So there is balance to find there.”
Very few LTI plans are currently used in CEO packages in New Zealand, the exceptions being those applied to local managers of global companies, says Richardson.
He says the survey did unearth both factual and anecdotal evidence of drop in performance pay in 2002 compared to the previous year, both in Australia and New Zealand.
“What it suggests is that because 2002 was tougher year, the level of bonus payments received did drop. So there is some evidence there of link between performance and pay but it makes up such an insignificant proportion in New Zealand that it makes very little difference.”
To compete internationally and drive organisational performance in New Zealand, local boards need to become more sophisticated and more competitive in how they reward CEOs, says Richardson.
“Local organisations should look at closing the gap in pay between Australia and New Zealand by increasing the use of incentive pay.”
Survey facts
The Sheffield 2003 CEO survey includes data from 511 chief executives, managing directors and general managers.
It found that in 2002, Australian CEOs (of companies earning annual revenues under $200 million) earned salary package 46 percent greater than their New Zealand counterparts.
That gap compares with 40 percent differential in 2000 and 43 percent differential in 2001.
The salary packages of New Zealand CEOs typically comprise 84 percent base salary/benefits and 16 percent performance pay (12 percent short-term bonuses, four percent long-term incentives).
This compares with an at-risk component of up to 60 percent in North American CEO packages and 46 percent in the packages of trans-Tasman colleagues.
Actual bonus payments received by New Zealand chief executives in 2002 were down on those reported in 2001.
Overall total level of remuneration received by this year’s sample of New Zealand CEOs ranged from $162,813 to $314,058 – base salary increase of 4.8 percent from the previous year.
Auckland CEOs are now typically earning more than their Wellington counterparts – it used to be the other way round.
