A preview of the Australian Productivity Commission’s perspective on executive pay
18/06/2009
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At Finsia breakfast seminars in Sydney and Melbourne on June 3 and 4 respectively, we heard the Productivity Commission’s chairman, Gary Banks, outline the scope of governance and remuneration issues being looked at, and perhaps give a directional hint to possible outcomes after more research and consultation.

In addition to looking at detailed technical issues and the functioning of the executive labour market, the Commission appreciates from submissions that there are “community” perspectives on “excessive” remuneration, where there are political dimensions which may need to be addressed. Commissioner Banks noted that the effects of intervention in a market, including this one, can be perverse and lead to unintended consequences. He also noted that issues of community sentiment need to be balanced with “national income consequences” and that these remuneration issues relate to “efficiency of firms and markets”.

A few particular points from the speech, which were not conclusions but appear to signal some of the thinking, are:

• Disclosure of equity grants can exaggerate the perception of the actual remuneration achieved, because not all equity grants vest and deliver actual value

• Use of performance-based pay (including equity grants) leads to higher “headline” pay numbers than an approach based primarily on fixed pay

• Corporate governance in Australia is stronger than in the USA; however there is not a proven causal link between strong governance and good corporate performance. Particular governance topics being reviewed (but without signalling the Commission’s conclusions on these) are: Directors as a “club” which perhaps would benefit from more members from outside the traditional sources of supply (and this could be facilitated by having lower bounds on the number of Directorships held by each person); independence of consultants; complexity of Remuneration Reports; the non-binding vote on Remuneration Reports (could it be strengthened in practicable ways?).

• There is no “optimal” executive remuneration model, even in theory, and the diversity of firms and requirements suggests that prescription of detailed approaches could easily lead to worse outcomes

• The dominant observed pay model involves a balance of three components (fixed pay, short term incentive and equity incentives) and current thinking probably maintains that with a bit more in the long-term/equity component

• Developing companies probably still need to use options (or equivalent)

• The role of shareholders in a company needs to be understood in a sophisticated way;

    • Shareholders are heterogeneous and do not all want the same thing in the same timetable
    • While they “own” the company in the sense of a claim to profit, they have limited liability and can sell at any time
    • Shareholders’ involvement is intermediated by the Board

• Alignment of the interests of shareholders, executives, the Board and the community involves a subtle balance

A link to the text of Commissioner Banks’ speech can be found HERE

Based on the indications to date, a thorough review is being undertaken which will look at possible improvements in governance and remuneration practices, and will test proposed changes against a realistic understanding of how well Australian practices are operating, and the risks of over-regulating.

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