Read Nicki Crauford's article (DominionPost, 14 September 2009). Telecom CEO Paul Reynolds’ remuneration package recently came under scrutiny with comments ranging from him being worth his weight in gold, his overall package being obscene and that compared to the Wall Street payouts his performance-related bonus was “peanuts”. It doesn’t matter who said what but each is worth examining.

There has been international antipathy for large salaries and bonus payments to CEOs of large corporates whose share price and capital value has been decimated by the global economic downturn.
This has been particularly vehement where large bonus payments effectively came from government bailouts and it is easy to find executives who look undeserving. In large corporates it is international practice for the CEO to be paid a base salary with the opportunity to earn considerably more with incentives such as share options.
Sol Trujillo at Telstra earned a total of NZ$16.5m in 2008 from a base salary of $3.6m, John Thain of Merrill Lynch earned $156m in the year the bank fell over but his base salary was only $1.26m. Paul Reynolds, therefore, may be handsomely rewarded by New Zealand standards but “it is apparent that if you want to attract an overseas executive you have to pay international wages”, wrote Chalkie in The Independent recently.

The job of a board of directors is to hire, fire and evaluate the company’s CEO based on performance and values, the quality of its management team and the coherence of its business model. When boards are operating as they should, directors are engaged in a vigorous, candid dialogue with the CEO and senior management about strategy and having the right talent in place to execute key initiatives. They are protecting shareholders not by wielding calculators but by deploying good judgment. The CEO is responsible for making that happen.

Shareholders may have a say in the remuneration, and shareholder activism is ensuring that this voice is being heard. However, shareholders as ‘owners’ of the company do not necessarily have the long-term interests of the company as a separate entity at heart, whereas the board is charged with the best interests of the company which is to generate wealth and add value.

Executive pay has grown faster than workers’ pay. The reasons are not sinister. Whereas workers’ pay depends on the labour market and has been kept down by huge numbers of people joining the global economy, managers’ bonuses are chiefly tied to returns on capital. Boards introduced stock options and hurdles when investors wanted executives to worry about profits. Before the crisis, profits were good, so pay was high.

The structure of bonus schemes is more important than their level. Geof Mortlock, who advises on financial, regulatory and governance issues on both sides of the Tasman, comments that remuneration-based incentives should be aligned to the desired outcomes for the firm which for most should be maximising the long-term net present value of the business.
Careful thought is therefore required on what those desired outcomes are. There should be an avoidance of excessive bias to short-term results (the downfall of Wall Street).
The board must take responsibility for ensuring that the incentive arrangements are in the best interests of the company and be sufficiently transparent so that shareholders and other stakeholders can assess for themselves whether the arrangements are properly aligned with performance and the long-term interests of the entity.
However, because a significant part of the remuneration may be tied to achieving milestones in the longer term strategic plan, and because this constitutes commercially sensitive information, the board must be circumspect in its public pronouncements.

Paying on performance is therefore not simple if the board is to achieve a healthy and realistic balance between short-term objectives, rising share prices and long-term objectives such as market domination and increased asset value. Structure it wrong and a ‘lucky’ chief executive might ride a huge upswing to collect massive bonuses and not give anything back when there is a downturn.

As for the charge of obscenity of Reynolds’ package, is it really about performance? One of the few economists who has maintained professional credibility by predicting the housing bubble crisis and the dot com crash is Yale’s Robert Schiller. “The biggest problem facing this country is not this crisis,” he warns, “it is the growing inequality”.

According to the philosopher Ivan Illich, in a consumer society there are inevitably two kinds of slaves: the prisoners of addiction (greed) and the prisoners of envy. So, whether the Seven Million Dollar Man is a paragon of business smarts or a showcase of corporate greed is arguably as much our problem as the Telecom board's. Frankenstein’s monster was, after all, a human creation.

(Source: IoD)