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The Resolution

If the CEO gets 100% of at risk compensation every year, the system is broken

Defending executive compensation is impossible unless we get serious about “at risk” compensation

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Executive pay is a hot topic in Australia today. We’re in a low growth environment and the affordability of basics like housing and energy are under threat. This is raising concerns about income inequality that are exacerbated when executives are seen to have high salaries that only ever increase.

Determining executive compensation has always been a big challenge. But from my perspective the biggest part of the challenge today is how contentious “at risk” compensation has become. Many commentators say “at risk” design is flawed.

There’s a perception that failed efforts are rewarded

The absolute level of executive salaries in large Australian companies in industries such as financial services are increasingly difficult to defend, particularly when compared to the wages of entry-level employees. The core of the problem appears to be that at risk remuneration is increasingly baked into the perceived base of many executive salaries. The relationship between risk and reward is not immediately obvious – in some companies it has been broken.

It’s become too easy for at risk remuneration to viewed by executives as if it is part of their base remuneration. Until individual companies rectify that part of the design of their remuneration systems we are going to continue to be dogged by this complex debate. Companies need remuneration systems that are perceived as fair and actually operate the way they were designed to. Boards, of course, always retain discretion to deal with circumstances that were not contemplated such as an asset acquisition.

Australians are inherently fair people. If someone has a job that involves a lot of risk most will accept it’s fair to give the opportunity to receive a high reward. We understand, for example,  that our sportspeople, particularly footballers, are paid well because they have put in a huge effort to get to the top. They have a short lived career and every day take the risk that they may get injured.

When it’s perceived that executives are being paid for failed efforts and mistakes, or their risks are asymmetric (“tails I win, heads you lose”), then the investing public has the right to be irate. We don't mind if people have a go and don’t succeed. But if well paid executives take risks and are not successful then many Australians would likely not feel comfortable with a full reward being paid just for “having a go”.

But corporate executives don't have anything analogous to the knee injury. They don’t sit on the bench as part of the team and go through rehab and physio to get themselves back out there - there’s no corporate equivalent. So when individuals are seen to stay on the field and be rewarded even though the business isn’t performing - it isn’t perceived well.

This issue must be resolved over the next five to 10 years

The issue of executive remuneration should be resolved over the next five to 10 years. The issue is out in the open and we are now having meaningful conversations about it. Proxy advisors and commentators have stepped aggressively into this space and non-executive directors are more open in their commentary on the topic.

We've also seen some boards take very bold steps - executive bonuses have been cut right down to $0. New chief executives have come in on lower pay than the predecessor, as should be expected. After all the predecessor has more experience in the role and a track record so they should be able to command a higher price.

So all the settings are there for us to change the system.

It’s also the right time to have this debate. We have a low growth economy at the moment - wage growth is low and some people may be seeing zero to negative growth - actually going backwards. It’s very difficult to tell people with zero wage growth that things are fair when they see headline executive salaries that are, in most people’s opinions, indefensibly high.

We want to build an equitable economy where a rising tide lifts all boats. That’s when people believe their children and their children's children are going to enjoy a better standard of living. That’s the Australia I want to live in, and to achieve that, we must address executive compensation.

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