More CEOs grab bonuses

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:

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.

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:

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?

Acsi Ceo Pay in the Top 100 Companies 2010

Comments

  1. And all the evidence seem to suggest that bonuses don’t encourage good performance

    “when we included a task that required even rudimentary cognitive skill, the outcome was the same as in the India study: the offer of a higher bonus led to poorer performance.”

    http://danariely.com/2008/11/20/what%E2%80%99s-the-value-of-a-big-bonus/

    Dan Ariely is a leader in behavioural economics experiments and one of the main findings is that bonuses are bogus. Read more at his blog or just google him.

    • +1 they certainly don’t encourage robustness of future earnings.

      Bank CEO should not have any bonuses whatsoever, since they are in effect utility companies.

      It’s like giving the nuclear power plant safety engineer a bonus for saving costs and increasing power output by optimising the system to the n-th degree….

      • Thanks H&H for the article.

        This is an open question – but do you feel that companies can implement ANY sort of bonus structure that truly rewards good, sustainable long-term behaviour from CEO’s? Or is the answer simply going back to the days of putting in 20 years of equity for the windfall payoff at the end?

        To use your example Prince – should we be rewarding the safety engineers for increasing safety precautions? That makes sense right? …similarly, should bank CEO’s therefore be rewarded for NOT taking risks?

        I still feel SOME sort of ‘bonus’ structure can be implemented to reward these good behaviours – but just not 100% sure of the details.

        What *really* irks me however is the justification of remuneration committees saying that they need to pay these high bonuses to attract ‘top talent’. With some of the decisions this ‘top talent’ have been making, you’d be grateful if you couldn’t afford them…

      • With some of the decisions this ‘top talent’ have been making, you’d be grateful if you couldn’t afford them…

        Beautiful! 🙂

      • Cap cash pay @ $200k p.a. Rest of the pay in common stock with a 10 year escrow. Executives to receive cash dividends on any shares they own through such as scheme as normal. See how behaviour changes then.

      • Further, wouldn’t it be nice if a system such as this applied to any occupation where people are paid to look after other people’s money – fund managers for example should have any pay over the cap invested in the funds they manage, with appropriate hedging in place if required – such that long term pay correlated directly with value delivered to clients…

        Those who say talent would go elsewhere, what a crock of shit, you can still make heaps of money (more arguably) if you create value for your clients/business owners. The people who would leave would be the ones that don’t want their skin in the game. Good riddance.

      • Leo,

        “…should we be rewarding the safety engineers for increasing safety precautions? That makes sense right?”

        That depends.

        If the task of “increasing safety precautions” is included in the job description for the position in question, then we are already rewarding them. They get their pay every month for doing their job.

        If, on the other hand, they make a contribution to the enterprise that is outside of their primary sphere of responsibility, then, yes, they should be rewarded above and beyond.

        Many companies address this issue with “Suggestion” incentive schemes. Generaly, an employee does not get an incentive payment for some endeavour or idea for which he is already being paid.

        If the job description of these CEOs includes the requirement to run the company and make a profit, then I guess you’d have to ask that if they do so, isn’t that what they are already being paid to do?

        Just as an aside to your comment about “top talent” – does anybody else get a grating feeling ever time the CEO of an Australian company is on TV and delivers his news in an American, Irish, South African (add whatever you like to the list) accent? I am far from xenophobic, but don’t we have any good Australian managers and engineers out there?

        Or is it de jour these days to have some exotic accent to prove how globalised you are?

      • Good questions.

        For the banks, the best solution is one I can’t suggest and probably un-achievable.

        Break them up into commercial, retail and trading banks, whereby the former and latter can only be owned via partnership (i.e up to 50 partners), AND are not subject to ADI/APRA/Basel rules.

        I.e they can take deposits, but they and their depositors will not be covered by government unlike retail banks/building societies.

        A commercial bank cannot do transactions with private persons – only businesses and between banks. The trading bank can only do transactions with HNWI, hedge funds, traders, commodity/future etc. No personal wealth management. Again this has to be a separate arm (e.g Colonial First State).

        None of the banks can own shares in the other types of banks. Complete separation is crucial. Cross ownership must not be allowed for robustness of the whole system. You must be allowed to let trading and commercial banks to fail.

        The trading/commercial banks can have bonuses up to the wazoo – since the profits go to the partners, whilst any losses, well, they are paid by the partners!!!

        Retail banks can only pay salary, with clawback on loan defaults. i.e if a bank builds its loan book aggressively and the arrears rates doubles, the manager gets his pay cut in half.

        Since running a retail bank (i.e your services are home loans, personal loans, term deposits, credit cards and that’s about it) is relatively easy, why would you need a CEO with a $10 million salary?

        So the question is more about just bonuses, but actual structure of the underlying operation and moral pride in your job.

      • I think even the CEOs and operating managers of systemically important retail banks should be made to have 90% of theirs, and their spouses assets locked in the equity of the bank (shares not options), and are not allowed to sell until 3 years after they leave.

        That is the only way to ensure management do not take excessive risk.

      • I’d replace the 90% of assets locked into equity with the death penalty for the CEO.

        Banks that are propped up by government will all herd together, game theory says they will.

        The only thing that prevents the worst of game theory is death to the participants.

        That is why most games of chicken do not end up in collisions, that is why MAD didn’t see the destruction of the planet.

  2. Why stop at greed by execs? The whole basis for economics is greed. It assumes people will only work if they get something in return. It assumes that people are unwilling to cooperate, to help others for no immediate return. Economics assumes that the profit motive is the only driver of human action.

    How can you then argue that the system has failed if the system is designed to encourage people to take more than they give?

    • The current system fails because the board of directors is too close to management, so bonuses are given out even when it’s not deserved. Under the current regime, the small shareholders have no chance of electing their own independent directors to the board.

  3. Methinks it another area for fiscal reform. Discourage excessive bonus structure by increase company tax rates.

    • Anybody who attempts that kind of fiscal reform would become an instant target for vilification by various business lobby groups and their paid-for report-churning consultancies and MSM business commentators.
      .
      In no time at all, the person will be called a pinko commie who favours government regulation and big new government bureaucracy.

  4. I think question really is why are the shareholders sitting on their hands, while the hot-shot CEOs fly their companies into the ground.
    .
    Probably because the typical institutional/prop-trading shareholder holds on the shares for an average time of about 8 seconds.
    .
    The rest are us – poor super/pension fund investors and our trusty little fund managers, literally forced to invest in equities. 🙁

    • Agree Mav that its a shareholder issue and with your remarks about inst shareholdings.

      Some form of accountability requirement for the voting by trustees / fund managers might lead to a few more of them abstaining from voting (index funds, traders) thus giving those who have some concern for the future of the business some control over it.

  5. The thing with bonuses is how do you even know what you are measuring is in the best long term interests of the company?

    Also, lots of other professionals get by without any bonus system so why do CEOs have to have them? If they need bonuses just to do their job then they are unprofessional and you are probably better off without them.

  6. I worked for LogicaCMG for a period of 4 years where a pay freeze was in effect (due to “economic circumstances”). Amazingly, we found out that throughout that period the executive hadn’t suffered from this restriction at all. They had in fact been feasting on fat bonuses. This came to light through compulsory SE reporting and not of course via the company’s HR department. Morale was at an all time low when I left. Obviously nothing had changed by 2009 as the CEO’s pay tripled in the face of 1300 jobs lost.
    Here’s to greed..

  7. It doesn’t stop at bonuses and extends to power. Large corporations influence politics by lobbying and bribing, very often in a subtle way by offering jobs to politicians in return for earlier favours. The idea of a publicly traded company, or at least the way it has been implemented, is seriously flawed. As mentioned in the posting above CEOs wield a lot of power and obtain significant gains without risking their own capital. In a way they are like elected politicians and the most their risk is being sacked at some point by those who elected them. Both western democracies and public companies seem to suffer from similar problems and we can see the compound effect of their interaction.

  8. I have no problem with bonuses, but likewise for bad performance their should be pay deductions or sackings.

    I feel its very “pinko-commy” BS from alot of the comments on capping pay, how would you feel if someone came into your work (who had no right to say anything) and cap your salary at $30k, its exactly the same principle..

    Let companies pay whatever they want to attract whatever talent, on the flip side also let those companies go bankrupt when theyve paid ‘overs’ for ‘talent’… if companies have a problem with regard to employees and company/shareholder interest not being aligned through remuneration schemes, let the company itself work that out, its in their interest after all. The idea of some more bureaucracy for ‘salary tsars’ does not sit well with me

    • also im not saying there is no problem as their clearly is in some industries, but some suggestions listed above irk me greatly

  9. Great fantasy party you’ve got going here ladies…it’s a pity none of it is either workable or necessary. I thought this site was supposed to encourage rational discourse…

    CEOs work according to the directives set down by the board in their remuneration plan. If these directives do not align with the strategic plan then who is really to blame? (I’ll give you a tip – it’s not the CEO)

    Bluescope’s CEO getting a $700k bonus for piling up $900 million of shareholders’ money and setting it on fire is entirely wrong but who let it happen? (Once again it wasn’t the CEO)

    Boards need to do a much better job of governance on these issues to ensure that rem decisions are consistent with the long term strategic plan, not simply market demands for ever greater rates of return.

    Corporations Act protections should not be extended to board members who act outside the interests of the business however, as always, who should be the judge of that?

    • ‘boards need to do a better job’ yeah great, workable solution buddy. Simple fact is current exec rem setup in many cases does not align interests of management with owners well enough.

      • so the companies lose out, go bankrupt, lose market share or whatever… would you suggest in electing a ‘Pay Tsar’?

      • I agree entirely but I still ask who you think is responsible for this current state of affairs?

        Whilst we should be able to expect better of these individuals, we can’t. There is nothing for them to lose in most cases as most of their package is guaranteed, or based on measures which should simply be hygiene factors, not percentages of the total bonus.

        Boards are in effect negligent if they fail to write a rem plan that aligns with the agreed and market communicated strategic plan and shouldn’t be sheltered from group action by shareholders if required.

        The big concern however, and nobody has commented on this fact yet, is that we still have a Corporations Act that places a responsibility on company officials to increase returns to shareholders. It does not say that this has to be in equity impacts, nor does it require good stewardship from one year to the next – jn fact there is no mention of responsibility to ensure longevity as far as I recall.

        I believe that many of these leaders are actually worth this amount of money, unfortunately most are simply those who have stepped on whomever required to scramble up the greasy pole that once was the corporate ladder. They look impressive but have little substance. I hate to sound like a sour gen-X but it smacks of pre-retirement opportunistic greed by baby-boomer execs with little understanding of where modern business trends are taking us. Most simply can’t comprehend how much change is coming our way in the near future, and how much risk this presents to shareholder value – it possibly explains the complete lack of vision in most large corporates.

      • H&H, I didn’t say that at all. What I was referring to was the general expectation from analysts and shareholders that whatever you did last year will not be good enough this year – the fallacy of the growth model of economics.

        We need to start measuring outcomes other than financial – the proverbial 3BL. Once again however is the difficulty of measuring this and penalising companies who fail to adequately serve the needs of multiple stakeholder groups. I tend to think that, over time, businesses who do this well will begin to outperform those who don’t.

        CEOs are still as much a part of the problem as boards and markets at present but that’s not likely to change in this generation of businss leaders (see my reply to Jake above.)

        I do remain optimistic for the future however.

      • but who would be in charge of measuring and penalising companies? surely the stakeholders would be the best to adjudicate and punish/reward companies accordingly?

  10. What do you expect when you hire mercenaries???

    They are not leaders. They are opportunists. OPM opportunists. Casino capitalist practioners. Exploiting the ignorance and apathy of the community. Why? Ignorance and apathy have been the only true broad based growth idustries in Australia since the 1990’s.

    If you are early in a chain letter… PONZI finance + inflation + debt.

    A few years ago in Singapore, when the going got both tough and rough a CEO led from the front by taking the biggest paycut-90%. He was in for the long haul. No fair weather sailor.

    In relationship based business model economies/sectors/compaines etc., there has to be a judgement of character.

    Leaders require character.
    Mercenaries are hired to fight. It is their fighting (competitive) ability that is bought. No character required.

    the 30 year war in Europe 1618-1648.

    The Thirty Years’ War (1618–1648) was fought primarily in what is now Germany, and at various points involved most countries in Europe. It was one of the most destructive conflicts in European history.

    A major impact of the Thirty Years’ War was the extensive destruction of entire regions, denuded by the foraging armies (bellum se ipsum alet). Episodes of famine and disease significantly decreased the populace of the German states, Bohemia, the Low Countries and Italy, while bankrupting most of the combatant powers. While the regiments within each army were not strictly mercenary in that they were not guns for hire that changed sides from battle to battle, the individual soldiers that made up the regiments for the most part probably were. The problem of discipline was made more difficult still by the ad hoc nature of 17th-century military financing. Armies were expected to be largely self-funding from loot taken or tribute extorted from the settlements where they operated. This encouraged a form of lawlessness that imposed often severe hardship on inhabitants of the occupied territory. Some of the quarrels that provoked the war went unresolved for a much longer time. The Thirty Years’ War was ended with the treaties of Osnabrück and Münster, part of the wider Peace of Westphalia.[12]
    http://en.wikipedia.org/wiki/Thirty_Years'_War