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$5b investor’s plan to fix ‘cult’ of excessive executive pay

SYDNEY, NEW SOUTH WALES – JANUARY 06: Allan Gray CIO Simon Mawhinney poses for a photo on January 6, 2017 in Sydney, . Fundie (Photo by Brook Mitchell/Fairfax Media) Prime Minister Malcolm Turnbull during a division on the motion to suspend standing orders, at Parliament House in Canberra, on Wednesday 8 February 2017. fedpol Photo: Alex Ellinghausen
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The expression “heads I win – tails you lose” neatly sums up the pay experience of a large portion of corporate chief executives.

It’s more than just the quantum of their earnings – the broader community’s response to which has become fever-pitched outrage.

Calling out excessive pay is now the strategy de jour for the likes of politicians. But while Malcolm Turnbull’s reference to executive pay as a “cult” of excess is popular with the electorate, the fact remains that the system needs an overhaul.

But there is a more deeply enmeshed and complex reason that even underperforming executives are being rewarded with pay packets that can border on the obscene.

It’s all about the structure of how management is rewarded with performance-based financial incentives – short- and long-term incentives on top of what is often generous base pay.

Now one of ‘s most influential and outspoken investors, with more than $5 billion under management, Allan Gray, has not only called time on these remuneration practices but has devised an alternative structure.

And it is now pressuring the companies in which it invests to adopt it.

As Allan Gray’s managing director, Simon Mawhinney, sees it, bonuses should be rewarded for past performance. But this is not the case in many major n listed companies, which he says use complicated and opaque scorecards to determine both long and short-term incentives.

These are then paid to executives based on equally complex and often flawed vesting conditions, he believes.

While some more extreme examples of pay have been voted against by shareholders at annual meetings, there are plenty more that slip through because they are too difficult to understand.

Mawhinney says he regularly hears feedback that management places little value on the long-term incentive portion of their remuneration due to difficulties understanding the structure of the rewards and the risks associated with its vesting.

“This is staggering given the cost of these schemes to shareholders. It is quite possible that high base salaries and short-term incentives – often with large cash components – are now used to compensate executives for the risk that their long-term incentives do not vest.

“This results in executive remuneration pay-off profiles that are asymmetrical with little downside.”

In other words, bad outcomes are well remunerated because even if long-term incentives are not paid, the base salaries and short-term incentives are still generous. And if the executive does perform well, he or she will get paid long-term incentives and end up with a huge reward.

So why are short-term incentives paid when outcomes are bad?

One reason is that, all too often, the decisions made by an executive can look good at the time. It is only years later that the strategy blows up – by which time the executive has more often than not left the building, taking their big pay packet with them.

Another reason is that the payment of bonuses doesn’t seem to need a particularly high bar.

A recent report from the n Council of Superannuation Investors (ACSI) noted that even though bonuses should be for exceptional performance, the vast majority of the 83 ASX 100 chief executives included in the study received a bonus last year. The figures also showed that when a CEO was granted a bonus, they were typically paid almost 70 per cent of the maximum amount.

Allan Gray’s model amalgamates all executive bonus incentives into a single bonus scheme – which it calls an executive incentive plan – which among other things eliminates short-term cash bonuses and is easy for shareholders to understand.

The bonuses are made in shares, which are held by the company but not given to the executive for between three and five years.

So if the business performs well over that period, the executive will ultimately be rewarded.

But if the business has not done well and the shares have fallen, the executive will receive less when he/she finally gets access to the stock. In this way, Mawhinney says, the executive is far more closely aligned with the shareholders.

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