Judging from the caning executive pay received on the release of company annual reports, most reasonable people would assume that executives were paid too much for mediocre performance.  An analysis by Guerdon Associates reveals this is not so.  If anything, many boards may be too tough. This may be surprising, given the rhetoric from various interest groups at company annual report time.

In addition, we also found a distinct improvement in alignment since new remuneration disclosure requirements were put in place.  That is, the initial disclosures in 2005/2006 had many examples of non-alignment between pay and results.  Yet a year later, there was a significant improvement as companies received shareholder feedback on their initial reports.

We analysed pay for CEOs from 85 ASX 200 companies that had the same CEO for years 2005, 2006 and 2007.   We then compared the changes in CEO ‘at risk’ pay, fixed pay and total pay against total 1 year return for each of these years.

We found that for total pay, in both the 2005-2006 and 2006-2007 years that we studied, more than 15% of CEOs had a decrease in their total pay from the previous year despite their company’s increase in total return.  The figures below illustrate this.  The Y axis shows the percent change in total remuneration, while the X axis shows the annual change in total shareholder return.  Each circle represents a company, with the size of the circle representing its market capitalisation relative to the other companies.  A blue circle company is providing an increase in remuneration as performance increases, a pink circle indicates both a pay and a performance reduction, a green circle represents a company that increases pay while performance decreases, while a red circle indicates a performance increase while pay decreases.

Figure 1 shows that in 2005/2006 there was reasonable alignment between CEO total remuneration and shareholder returns.  Even so, many mid-size companies’ CEOs received a decrease in pay for positive TSR.

Figure 2 below shows more discipline in 2006/2007, as CEO total remuneration increases became more closely aligned with shareholder returns.  Nevertheless, a significant proportion of companies with good performance paid their CEOs less, while other companies with outstanding performance displayed relatively modest overall increases in CEO total remuneration.

The element of pay expected to be most closely aligned with annual shareholder returns would usually be short term incentive (STI) payments.  Figure 3 below shows changes in STI with changes in TSR for 2005/2006.  It can be readily seen that there is little alignment between shareholder outcomes and executive bonus pay.

However, the following year sees a major shift.  Figure 4 shows a clearer alignment between annual shareholder returns and CEO bonus pay.  Nevertheless, there are still instances where CEO bonus decreased while shareholder returns increased.  This can probably be explained by the fact that many companies have bonus plans based not only on short term financial results, but also on achieving tangible milestones for sustainable longer term outcomes.

Interestingly, there are very few instances of pay increases for poor performance.   And where they occur, they are vastly outnumbered by companies with demanding boards that thought the CEO’s good returns were not quite good enough for an increased bonus.  This should be clearly understood as the government considers further amendments to disclosure requirements for better alignment of pay to performance (see HERE). 

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