Welcome to Guerdon Associates’ May 2006 newsletter.

In this month’s newsletter we focus on the issue of short termism. We outline the components of “termism”, the impact of expected tenure, why some performance measures will not have the effect intended, and we ask if it is better to be long term or short term. We use CEO and CFO pay and career data to illustrate our case. We also have a bit to say on boilerplate pay policies and the excuses or otherwise for it. We conclude with the latest on executive and director remuneration disclosure updates available in the GuerdonData™ on line database.

The Components of “Termism”

The time focus of an executive is subject to six easily ascertainable variables.

It is these that the board’s nomination and remuneration committee needs to address in the company’s hiring and pay process to achieve optimal shareholder returns.

• The executive’s perceived likely tenure;
• Reward focus;
• Reward value;
• Likelihood of achieving required performance outcomes;
• Controllability of outcomes;
• Availability and frequency of performance measure feedback.

In the articles we cover in this issue we will touch on each of these.

Tenure

Tenure may have a surprising influence on an executive’s performance focus, particularly at the CEO level. The tenure of Australian CEOs is less than most other Western countries.

Based on turnover rates in GuerdonData™ over the past two years, the likely tenure for an Australian based CEO is 4.5 years. This is not much better for reporting executives, with the likely tenure of a CFO being 4.7 years. This is stated in the figure above, with turnover shown on the left hand scale, and the tenure this translates into on the right hand scale.

An experienced senior executive may not know the exact statistics, but they have been around long enough to know the probable time frame. For the CEO in particular the tenure issue is exacerbated by the additional probability that the role is likely to be the last full time career position the CEO will have.

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Reward Focus - A Bird In The Hand Is A Bit Like A STI…

And the two in the bush is a bit like a LTI.

Even if we assume that the LTIs and STIs are equal in difficulty (but they are not – see below), a STI and a LTI that are otherwise equal in value still would not command equal attention. Psychologists would say that proximity or immediacy of reward adds to its “value”. So, all else being equal, a LTI needs to provide more value to get just the same level of attention from the CEO. Secondly, the same psychologists would say that the longer term reward may be subject to more uncertainty due to unknowable factors (merger, disability, economic recession, or climate change) that further discounts its value.

So, if the board wants a better balance to the emphasis on both short term and long term results, it may need to add a few more dollars to the LTI just to have the same pull as the STI.

Effort, Luck and Value

Human beings will direct effort to achieving outcomes that they can influence and that deliver the most valuable reward.

Offering a LTI that is 3 times the value of a STI will not overcome short termist tendencies if the LTI measure is one over which executives have little influence. As we have said several times in past newsletters, relative TSR is an excellent conceptual basis for performance comparison. But it falls down repeatedly in execution. Unless TSR is measured against real competitors for revenues, customers, labour, capital, and suppliers it is irrelevant. In a shallow market like Australia’s there could be few real competitors. But we have not encountered too many relative TSR performance requirements where the competitors are honed down to the four of five that are the real competitors. And selecting a larger but disparate group, such as the ASX 100, just does not cut it. A disparate group, like the ASX 100, will, by definition, comprise companies at different points in their different cycles. Therefore it would be highly probable that “peer” companies in a large index will deliver both higher and lower TSRs as a result. So a relative TSR outcome is more due to luck than skill. Why bother?

Some companies have recognised this, and selected LTI measures over which the executives have more influence. And some governance and shareholder groups have also recognised this, such as the Australian Shareholders’ Association.

But for the majority of ASX 300 companies, the behavioural impact of the LTI requirement is the opposite of what is intended, with the CEO focus on the short term!

Short Term Vs. Long Term Results

What is best for shareholders? To focus on longer term returns, which may mean foregoing short term results, or to constantly strive for short term improvements?

The fact that many shareholders are not in for the long term makes the picture more complex. This was recently recognised by Don Argus during an address he gave to the Australian Institute of Company Directors. He noted that companies needed to recognise this constituency, represented at the extreme by the ‘day-traders’ who may be in and out of a stock within a matter of hours, and find a way to communicate effectively with them about expectations. Mr. Argus also highlighted the directors’ need to balance this with the long term health and sustainability of the business.

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Optimising Shareholder Returns Can Never Be An Outcome of Boilerplate Pay

We never cease to be amazed at the lack of variety in executive pay. Fixed pay, and STI based on annual results, and a LTI based on relative TSR. That’s it.

The same suit of clothes for the short fat bloke as for the tall skinny bloke. Is there anyone paying attention to what the business needs? A simple graphic of monthly earnings volatility over 5 years will illustrate business cycles. Adjust pay plans to the earning cycles of the business. If a fashion brand has a 6 monthly winter/summer cycle then consider a STI that measures 6 monthly results, not annual results. Likewise, if exploration leases take 7 years to survey, plan, construct, mine and turn into alumina just in time for the next planned commodities up cycle, then design an option plan accordingly. If a biotechnology company has all its eggs in a risky wonder drug research effort, provide just enough salary to buy the groceries, and a single mega grant of 4 year options to sweat out a billion dollars’ return. If the business is about acquiring established brands to incorporate into existing manufacturing and distribution infrastructure, put in place the 18 month medium term incentive required to focus on investors’ expectations of earnings accretion. Where o’ where, corporate Australia, is the differentiation required for competitive advantage?

The Devil Made Me Do It

Well, not exactly the devil, but those investor and proxy governance groups.

We have heard this many times – the argument that variety and tailored pay for performance solutions that best optimise shareholder returns are not applied because they fail one or more of the various prescriptions of these groups. In our experience we have not had a pay policy or program criticised because it did not meet a standard prescription. Australia is fortunate that all our proxy and governance groups will listen to pay proposals. Often where there is failure to have a pay proposal supported, it can be attributable to a deficiency in communication. That is, if a pay proposal is truly in the best interests of shareholders and has been rejected, it seems to be due to an absence of understanding that could be remedied with direct, clear and concise communication.

Latest GuerdonData™ Updates

This month’s updates to GuerdonData™ include disclosures from the following 32 companies:

Adelaide Brighton Limited, Alinta Infrastructure Holdings, AMP Limited, Aristocrat Leisure Limited, Babcock & Brown Limited, Biota Holdings Limited, Calliden Group Limited, Coca-Cola Amatil Limited, Funtastic Limited, Henderson Group PLC, Highlands Pacific Limited, HPAL Limited, Invocare Limited, MFS Limited, Minara Resources Limited, Multiplex Acumen Property Fund, MYOB Limited, Oceana Gold Limited, Oil Search Limited, Petsec Energy Limited, Pharmaxis Ltd, QBE Insurance Group Limited, Queensland Gas Company Limited, Roc Oil Company Limited, Rubicon America Trust, Rubicon Europe Trust Group, Santos Limited, SFE Corporation Limited, Sino Gold Limited, St Barbara Limited, STW Communications Group Limited, and Tap Oil Limited.

Executive and director remuneration data from all ASX 300 companies on GuerdonData™ is available to any subscriber. Visit our website for more information on GuerdonData™.

Assess how easily you can find out director and executive pay information by viewing our 6 minute demo. Click on the “More Info” button below.

Guerdon Associates in the News

Robinson, Michael 2006, “Company directors are working hard for the money”, Australian Financial Review, 21 April, p 75.

Hanley, Mike 2006, “Losing Pace”, CFO, April, p 16 – 28.