Recently there has been more than usual criticism of executive pay. The main issue is the apparent disconnect between company performance and executive bonuses.
Media, political, and investor sensitivities have been increased by evidence of major abuses in the US system of executive compensation (but what can you expect with their governance systems – see HERE), and respected international bodies’ assessments that banker pay contributed to the world’s economic problems (see HERE).
Unfortunately, Australian executive pay has been tarred with the same global brush, and with much reporting comprised of sweeping and unsubstantiated statements. While we think a few instances of criticism are justified, many references to specific companies are the result of the fact that the current available remuneration information for most companies reflects the good economic times that existed for most of the year ended 30 June 2008, when company performance was good and bonus payments were high and share prices were still at comfortable levels.
The remuneration outcomes for the year ended 30 June 2009 will tell the story – we expect incentive pay will be sharply reduced in many companies, and results to date support this.
But throughout the debate, there is little understanding of the impact that the share market losses have on executive wealth. That is, all the reports so far have focussed on disclosed annual pay (which includes the accounting value of equity grants that are now unlikely to provide a reward), and not the commitment most CEOs demonstrate with their ongoing investments in the companies they run.
The extent of alignment between changes in CEO shareholding value and the absolute and relative ‘total shareholder returns’ (TSR) experienced by shareholders has been ignored.
Our research indicates that the net worth of most ASX 100 CEOs has fallen by the equivalent of 100% or more of their total annual pay, with the reductions (generally unrealised) for more than 70% exceeding $1 million.
There is much more sharing of the pain than has been realised.
It will come as no surprise that CEOs’ wealth in company stock has reduced over the past year. But who has been hardest hit and what factors aggravated or mitigated it?
We focused our attention on ASX100 companies with CEOs who had been in the role for the last two reporting periods. We used the most recent disclosures to determine how much equity the CEO holds and then compared the value at the beginning and the end of 2008, using actual stock holding multiplied by prevailing share price at beginning and end of the period.
For our purposes, equity was defined as shares and vested options and rights.
Three CEOs with no shares and no vested options or rights were excluded.
Options that were underwater were given a zero value. Options and rights that have not vested were excluded to simplify the analysis.
Remuneration data was sourced from GuerdonData® and financial data was sourced from Bloomberg and Aspect Huntley.
The descriptive statistics are telling, so stick with us as we do a little number crunching.
There were 56 CEOs in our sample.
Only three CEOs experienced an increase in the value of their equity during 2008. They were all in the energy sector. Origin Energy fared best followed by Santos and Arrow Energy.
The biggest losses in value included Babcock & Brown, Goodman Group, Riversdale Mining and Transfield Services, all of which had falls in CEO (or former CEO) share value of more than 80%.
In terms of large absolute (i.e. dollar) reductions in equity value, the CEOs of both Fortescue Metals Group and WorleyParsons experienced losses of more than one billion dollars.
Average statistics are always affected by very high and very low data and the change in equity value is no exception. The percentage change approximates a normal distribution and looks like a bell curve. That is, most individuals are in the middle, with a small number on either side. The absolute change in dollar value is much larger for the few individuals who own a significant proportion of company shares. Although the percentage change may be in the middle of the data range, the individuals have suffered extremely large losses in equity value, by virtue of their large holdings.
The following table summarises the change in equity value from 31 December 2007 to 31 December 2008 for CEOs of ASX100 companies.
Note that the average is skewed (negatively) by several very large negative values.
- 71% experienced a reduction in the net value of their equity holdings of more than $1m
- 50% experienced a reduction in the net value of their equity holdings of more than one year’s Total Remuneration (TR)
- 38% experienced a reduction in the net value of their equity holdings of more than two years’ TR
Influence of Other Factors
There was a marked difference between CEOs who owned a significant proportion of the company and those who did not.
As discussed above, if a CEO has large share holdings then the absolute reduction in equity value (when share price movement is negative) is large, however, the percentage change was also larger. Interestingly, this is because the share prices of companies in which the CEO has a large holding have fallen more than for companies in which the CEO has a relatively small holding.
The following table and graph summarise the findings.
We analysed our result to see if there were any underlying relationships between the percentage change in equity value and company financials such as performance, size and risk.
The following table shows the R squared statistic for several variables and the percentage change in CEO equity value during 2008.
With the exception of beta, all of the relationships are positive, that is, they increase as the change in equity value increases.
The relationships are quite weak, but they imply what we expected; that smaller companies with low returns have experienced a greater percentage drop in equity value than have larger companies with higher returns. We expect the relationship between change in equity value and beta to be negative because a high beta means larger than average movement relative to the market. When the market drops, companies with a high beta will drop more than average.
Interestingly, there was no relationship between NPAT or change in NPAT with the change in value of equity holding. These relationships are sometimes blurred because there is strong variability caused by other factors that interfere with the relationships. We have already discussed the influence of company ownership, but we expected industry would also influence levels of variability.
The following table summarises the variability in the average change in equity value along with company performance by industry.
Banking and insurance were reported separately to real estate and diversified financials because the reduction in equity was significantly different.
For the sample as a whole, the relationship between TSR and change in equity value was quite weak, explaining just 12% of the change. However, on an industry-by-industry basis, the relationship is much stronger.
The following graph shows the relationship between the change in equity value and TSR broken down by industry. When we take a relative TSR within each industry, the relationship becomes much stronger. Relative TSR explains 53% of the variability in the change in equity value.
The following graph shows actual 3 year TSR and a relative TSR statistic compared to the % change in CEO share value. The relative TSR (red line) has a much stronger association than absolute TSR, implying that the market is more concerned with relative than absolute returns.
The extent of alignment between changes in CEO shareholding value and the absolute and relative TSR experienced by shareholders should not be ignored.
Most CEOs have suffered a reduction in the value of their company equity holdings equivalent to 100% or more of their total annual pay, with more than 70% losing more than $1 million.
There is much more sharing of the pain than has been realised.© Guerdon Associates 2022 Back to all articles