The ‘myths’ that justify huge pay packets for chief executives

By Jackson Stiles

The revelation that Australia Post chief executive Ahmed Fahour is being paid $5.6 million a year has sparked fresh outrage over corporate greed, as experts refute the theories used to justify huge executive salaries like these.

On Tuesday night, a Senate committee forced Australia’s government-owned postal service to reveal that Fahour was paid $4.4 million in salary and $1.2 million in bonuses last financial year, eliciting the disapproval of even the Prime Minister, who called it “too high”.

Australia Post had argued that revealing the salaries of Mr Fahour and other executives could hurt the company.

Read more: Three lessons from Australia’s highest paid chief executives

Professor Peter Swan, finance expert at the University of New South Wales, said the real problem is not the isolated example of Australia Post, but the broader issue of executive pay in the corporate world—pushed ever upwards by an “utterly absurd” demand for “so-called” independent directors.

A tenth of directors at Australia’s top 200 companies own no shares at all in the companies they oversaw in 2015, while others had very low stakes, according to the Australian Council of Superannuation Investors.

“Since these independent directors are not allowed to have significant share ownership in the company, they are approving the pay of CEOs and other executives out of someone else’s money, not their own, and thus have far less oversight over pay than they should,” Swan told The New Daily.

He proved this in a 2016 study, which found that company performance and investment decision-making worsened, while executive pay increased, the more ‘independent’ directors a board had.

“In privately-held and family-controlled large international businesses, we find much lower levels of pay, and where there is a substantial shareholder on the board, especially on the audit committee, once again we see much lower levels of pay and much better levels of performance.”

Another popular theory, called ‘managerial power’, says chief executives use their personal influence over sympathetic corporate boards to boost their pay.

Dr Andy Schmulow, a corporate regulation expert at the University of Western Australia, blamed directors for relying on the “fig leaf” of supposedly independent advice.

At most companies, a remuneration committee appointed by the board of directors sets chief executive pay based on the advice of external remuneration consultants.

“If you want to be a successful remuneration consultant, you have to recommend that salaries go up as much as is humanly possible without causing a shareholder backlash,” Schmulow told The New Daily.

A 2003 study, funded by the Labour Council of NSW, estimated that executive and chief executive pay diverged sharply from average weekly earnings in Australia from 1984 onwards. Whatever the cause, executive pay has skyrocketed.

Between 2001 and 2008, just before the global financial crisis, median fixed pay for Australian chief executives rose a staggering 120%, from about $780,000 to $1.7 million, the Australian Council of Superannuation Investors (ACSI) found.

Last year, median pay at the top 100 companies increased by 3.8% to $218,144 for non-executive directors, and by 5.1% to $462,084 for non-executive chairs, ACSI said.

For chief executives at the ASX100, median pay fell -2% in 2015 to $3.8 million, but this was more than made up for by a 5.8% rise in median bonuses to $1.6 million.

The ‘myth’ of the super-talented chief executive

The argument used most often to defend exorbitant chief executive pay is that talent is both rare and indispensable, and must be lured by large pay cheques.

But in his 2014 book Indispensable and Other Myths, US corporate law expert Professor Michael Dorff used the latest academic research to argue that the addition of performance-based incentives (stock options and bonuses) to “already-generous” chief executive salaries since the 1970s has not and cannot improve company performance.

Not only do senior executives have little impact on a company’s stock market value, but performance-based pay can actually erode motivation and sap executives of creativity, analytical reasoning and innovation, causing them to manage companies with a risk-averse and overly short-term view, he wrote.

“The current cult of leadership and lottery-type compensation packages that can result in generational wealth foster precisely the wrong sort of culture for chief executives, one that encourages them to put their own interests first and the company’s last.”

Read more: Former Telstra boss says his $27 million salary was indefensible

‘Follow Germany and the Nordic countries’

To moderate executive pay and improve company performance, Swan said Australia should follow the Nordic example by creating a “more shareholder-focussed governance system”.

Schmulow said we should follow the German policy of ‘Mitbestimmung’, which allows workers at large public and private companies to elect a number of directors. “In the Nordic countries, major shareholders have a much larger say in the remuneration and board appointments, and that could be very easily brought in in Australia.”

After last year’s BHS scandal, UK Prime Minister Theresa May proposed to “reform capitalism” by putting workers on company boards, like in Germany, and to make shareholder votes on remuneration legally binding.

She has since backed away from the worker idea, but seems committed to binding remuneration votes.

Dorff wrote that shareholder votes on executive pay should be made binding rather than advisory, and that large shareholders should be represented on remuneration committees.

In Australia, under the ‘two strikes’ rule introduced in 2011, investors can trigger a board spill if 25% or more of a company’s shares are voted against two consecutive remuneration reports.

Or do we focus on shareholders too much?

In a recent book, South Korean economist Dr Ha-Joon Chang complained that the principle of “shareholder value maximisation”, dominant since the 1980s, has resulted in the complete opposite for both shareholders and the wider economy.

“The managers saw their compensation rising through the roof, but shareholders stopped questioning their pay packages, as they were happy with ever-rising share prices and dividends,” he said.

Under this principle, long-term performance is sacrificed for short-term share price growth. Employee wages, long-term investment, inventories and middle-level mangers were “ruthlessly” gutted, and governments pressured to lower corporate tax rates. The resulting profits have been given to shareholders in the form of dividends and share buybacks in order to keep the market happy, Chang wrote.

“This unholy alliance between the professional managers and the shareholders was all financed by squeezing the other stakeholders in the company.”

Jackson Stiles is money editor at The New Daily, where this article was first published.