In The Great Crash of 2008, Ross Garnaut and I identified four major causes of the GFC: housing bubbles, global imbalances, clever money and greed. Pretty much none of these causes has been seriously addressed. But today I’m going to focus on the last.
Greed is a part of all bubbles of course, but in the case of the GFC, it was a particular type of greed. There was a stretching of what was thought to be acceptable return for corporate executives who made short term decisions. The book included this classic quote from Rodney Adler, interviewed by David James:
We might offer the last word on greed to Rodney Adler, perhaps Australia’s most notorious convicted white-collar criminal. Adler was a key player in the collapse of HIH Insurance, Australia’s largest corporate bankruptcy. In an interview with David James at BRW magazine in May 2009, Adler said:
“There has been a major change in the upper middle-management layer of most corporations. In the old days, which certainly I believe in, the standard organisation was that equity went into a company, and if you owned that equity after 20 years’ hard work you made a lot of money if you were successful.
About 10 or 20 years ago this all changed. All of a sudden these people on good salaries who hadn’t taken the risk, who hadn’t built the corporation, they said to themselves: ‘I’d like to be rich. I’d like to have equity in the company but I don’t want to buy it.’ And a whole new set of instruments evolved out of America, which then infested the rest of the world, certainly the Western world, where executives became owners but with no risk.
[At that point] capitalism as we know it changed. It is not capitalism because the risk has gone. The executives have the upside and no down-side. That is the problem.”
I have no problem with high pay. Reward for effort is an admirable principle. However, I do have a problem with bonus structures that encourage short term thinking and the arbitraging of one’s own firm. Actually, I have a problem with bonuses period. As I wrote earlier this year:
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If liberal capitalism is about anything worthwhile, it is that a system of private ownership has individual and collective benefits superior to other political/economic systems.
By breaking down the capitalist definition of ownership, bonuses serve to suck talent into unproductive and short-term activities. This promotes activity that arbitrages the health of the firm for personal reward. Converting bonuses to options and shares only goes some way to resolving this. Without extensive and drawn out escrow periods, as well as clawbacks, issuing shares as bonuses is window dressing.
Secondly, we are incentivising talent to join the great casino of arbitrage capitalism, rather than encouraging talent to begin their own enterprises. Bonuses are also fundamentally anti-entrepreneurial.
…According to management theory, the rationale for bonuses is the alignment of interests between owners and executives. This blogger reckons rather that by assuming this division of interests, the theory only serves to create a flighty class of delicate geniuses requiring ‘alignment’ wherever they go. Billions of average workers manage to get around this division every day.
Yesterday, the Australian Council of Super Investors released its annual report into the structure of CEO pay packages. And sadly, the signs are that the steady restructuring of CEO pays continues. From the report:
In 2010, total CEO median and average pay increased, with the median rising 8.6 percent to $4.388 million,the highest level recorded in the 10 years of the ACSI study. Increases in total disclosed pay came despitedeclines in average and median bonuses and fixed pay, with the average bonus among CEOs who received abonus falling to $1.574 million, the lowest level since 2005. The decline in average and median fixed pay, largely driven by the entry of 23 new CEOs to the 2010 sample, saw average top 100 CEO pay fall to $1.929million from $2.017 million. In line with the decline in fixed pay and bonuses, average and median cash pay – CEO pay excluding the value of equity incentives – also fell, with average cash pay falling from $3.405 millionin 2009 to $3.346 million in 2010, the lowest level since 2005. The impact of new CEOs on the sample isillustrated by the increase in fixed pay and bonuses for the 57 CEOs who were also included in the 2009 sample, with the incumbents enjoying increases in average and median fixed pay, bonuses and cash pay: Median fixed pay by 3.1 percent, median bonuses by 12.1 percent and median cash pay by 10.2 percent.
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So, bonuses structures on the up. But, it’s not all bad news. The report also illustrates that bonuses are a relatively small part of ASZ100 remuneration, even if growing:
High levels of fixed pay remain a feature of S&P/ASX 100 CEOs. In the 2010 sample there were nine CEOs including Frank Lowy receiving $3 million or more in fixed pay, down from 10 in 2009 (and down by more as a proportion, falling from 15 percent of the 2009 sample to 11 percent in 2010). The eight other individuals receiving guaranteed fixed pay of $3 million or more in 2010 were Rio’s Tom Albanese (inclusive of the accrual of his defined benefit pension), Coca-Cola Amatil’s Terry Davis, Leighton Holding’s Wal King, BHP Billiton’s Marius Kloppers, CBA’s Norris, Wesfarmers’ Richard Goyder, ANZ’s Mike Smith and Crown’sRowen Craigie.
As shown in figure 2.1, 41 of the 80 Top 100 CEOs in the 2010 sample received fixed pay between $1million and $2 million per annum (similar to 2009, when 53 percent of the sample fell into this range). In 2010 10 CEOs in the sample received fixed pay of less than $1 million per annum, or 12.5 percent of the sample,similar to the 8.9 percent of the 2009 sample who fell into this range. Of the 2010 sample 29 received fixedpay of more than $2 million (36 percent, compared with 37 percent in 2009)
But bonus structures are growing, as the report details:
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Annual bonuses, as observed in past studies, have become more frequent across the S&P/ASX 100 regardless of performance as the size of bonuses has increased (see table and figure 2.2 below). In 2010, if the eight CEOs in the sample who received no bonus are included, the 2010 average falls to $1.417 million. More entities paid bonuses than in2009, when 12 of the 68 sample entities paid no bonuses to their CEO (17.6 percent in 2009; 10 percent in2010).Cash bonuses and the impact of deferral. The eight CEOs who received no bonus in 2010 included Qantas’ CEO Alan Joyce. He accrued a $2.88million bonus for 2010 but the Qantas board elected to award this as Qantas shares subject to sale restrictions for two years after grant. Under Australian remuneration disclosure requirements these vestingconditions meant no bonus was recorded in Joyce’s 2010 remuneration and it will instead be amortised overthe 2011, 2012 and 2013 financial years. In the wake of the Global Financial Crisis, and regulatory and shareholder efforts to reduce the potential for executives to receive windfall gains in cash based on unsustainable performance many large Australian companies, especially in the financial sector have begun deferring significant proportions of annual bonuses into equity vesting over time.
The 2009 longitudinal study flagged the impact on disclosed bonus numbers in statutory remunerationdisclosures from this move to greater deferral and the 2010 study has for the first time captured informationon the total bonus accrued during 2010 for sample CEOs; this will be tracked over time in future studies. In2010 the average bonus accrued for all 80 CEOs in the sample was $1,738,225 (the median was$1,275,000) and the average if the seven CEOs disclosed as accruing no 2010 bonus are excluded was$1,904,904 (median $1,511,985). There were 21 CEOs in the sample who were disclosed as having adeferred element of their annual bonus at risk either through exposure to future performance or forfeiture on departure
I realise I’m tilting at windmills here. But bonus structures are a big underlying cause of arbitrage capitalism. Why own the company and take the risk when can work for it and earn virtually the same return at no risk?
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
