The US government’s latest financial intervention and regulation of executive pay is a response to an issue that fairly and squarely originated in its own backyard, but has infected the rest of the world. The associated executive pay crackdown is the product of politicians’ short sighted and opportunistic appeal to voters on the eve of that country’s November elections (e.g. see Senator Obama’s appeal to voters on executive pay HERE). The danger is that the US’s voter-driven but irrelevant regulation of executive pay may set precedents not only for the US, but for Australia and the rest of the world as well. 

And, as with previous US interventions, lacking is the vision to tackle the systemic causes of US executive pay problems and to fix regulatory anomalies that encourage the wrong reward structures.

The US regulation comes at a time when the Australian government is reviewing executive pay regulation. (see HERE). The US Congress’s Emergency Economic Stabilization Act of 2008 (see a summary HERE) requires the US Treasury Secretary to liaise with foreign authorities and central banks on the establishment of programs similar to its “Troubled Asset Relief Program” (TARP).

But the actions in the US bill are not even remotely applicable to Australia. We hope that the Rudd government’s keenness to be seen as internationally co-operative does not extend this far.

The US bill provides that the US Treasury will promulgate executive compensation rules governing financial institutions that sell it troubled assets.  Where Treasury buys assets directly, the institution must observe standards limiting incentives, allowing claw back and prohibiting golden parachutes.  When Treasury buys assets at auction, an institution that has sold more than $300 million in assets is subject to additional taxes, including a 20% excise tax on golden parachute payments triggered by events other than retirement, and tax deduction limits for compensation limits above $500,000. 

While restricted to companies receiving bailout relief, there is a concern that once legislation in the world’s leading economy is implemented for one group on an issue as contentious as executive pay, the genie is out of the bottle and could be extended more broadly.

But the US Congress should be the first to know that dictating what and how executives can get paid does not always work as expected. In 1984, Congress passed a law eliminating the tax deductibility of golden parachutes that exceeded three times base salary. Corporate America took that to mean anything below that multiple was fine: golden parachutes worth 2.99 times base salary proliferated, where before there were none at all. In 1993, Congress said only $1 million of an executive’s salary would be tax deductible. Soon this prescribed deductible maximum became the de facto minimum.  In addition, to ensure pay over this maximum remained tax deductible, companies began paying their CEOs large amounts in other forms, like stock options and deferred compensation.  The historically high rates of increase in executive pay stem from these regulatory attempts.  (For an interesting US research article that looks at executive pay since 1936 to now see HERE.) When combined with a Delaware legal code that favours management led by an executive chairman over shareholder rights, it is little wonder that American executive pay is in the state it is.  But none of the US Congress’s Emergency Economic Stabilization Act measures address these long-standing systemic regulatory failures on executive pay.

We suspect that Canberra’s bureaucracy already well understands that regulation can have disagreeable consequences, making the government’s task of meeting its election platform commitments to regulate executive pay difficult.  Fortunately, Kevin Rudd’s speech to the UN on 25 September included more insight on the global regulation of banker pay than all of the US Congressional representatives put together (see HERE).

And Australia could not be more different from the US.  With very few exceptions, Australian executive termination payments are reasonable, with most limited to 12 months fixed remuneration and prorated incentive plan pay-outs that take account of performance.  Very large payouts require shareholder approval.  Australian CEO pay levels are also reasonable, and comparable to or less than the undisclosed remuneration of leading professional services firms, many private entrepreneurs, professional sportspeople and entertainment celebrities. 

This is not to say there are not executive pay issues in Australia.  There are. And some of these, too, can be attributed to existing regulation, rather than the lack of it.

For example, Australia’s current tax system requires that tax is payable on any equity incentives if the executive leaves employment, even if they are still subject to performance-based vesting conditions.  So Australian companies are moving their executives’ incentive pay into annual bonuses instead of long term equity. This makes it difficult to hold CEO’s accountable if the company falls over the next day or 2 years later as a result of decisions on his/her watch.

Interestingly, the UK may be taking a less regulatory, more flexible but less certain route. As recently as June this year the UK government was insisting that it would resist calls for direct regulation of executive pay and that executive pay is a matter for boards and shareholders, not for governments (see our June newsletter report HERE).

But it looks as though the recent cataclysmic events on world financial markets have forced a change of heart for the UK government.  In a speech to the 2008 UK Labour Party conference on 22 September 2008 (available HERE), the UK Chancellor, Mr. Alistair Darling, said

“I can promise that wherever weaknesses are found in the financial system – whether in the powers of Government, the Bank of England or the Financial Services Authority (FSA) – I will take steps to deal with it.
It’s essential that bonuses don’t result in people being encouraged to take on more and more risk without understanding the damage that might be done, not just to their bank, but to the rest of us in the wider economy…Bonuses should encourage good long term decisions, not short term reckless ones.  But the problems we face are also global – and will require global solutions.  Just as no government on its own can combat global terrorism or tackle climate change, so no government alone can put in place the right supervisory safeguards in this global economy.
In the next few weeks [UK Prime Minister Gordon Brown] and I will be in the US and Europe working with our counterparts to put in place the measures internationally needed to prevent the mistakes and misjudgments which caused this crisis.”

The FSA has begun scrutinising bonus policies during its regulatory visits, and will analyse pay deals as part of its risk assessments of firms it regulates, but does not intend to regulate individual bonuses.  If the FSA believes pay arrangements create additional risks, it may make a requirement to put more capital aside to cover it. 

In conclusion, Australia’s executive pay practices, to date, have been relatively well managed – we would do well not to make hasty changes in response to irrelevant global regulatory overtures.

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