A fair day’s pay for a fair day’s work?

It seems CEO pay packets have reached almost unprecedented levels. According to a recent report from the Australian Council of Superannuation Investors, all but six of the 80 CEOs of Australia’s 100 largest companies who were eligible in 2017 received a bonus. The report also called for greater transparency around how bonuses are calculated, after it found CEO pay packets at Australia’s 100 biggest companies climbed back to pre-Global Financial Crisis levels in 2017.

At Allan Gray, the way CEOs are remunerated is an issue that is close to our hearts. We regularly push for improvement with the boards of the companies we meet.

We believe efforts should be rewarded, but in our view rarely do current bonus schemes have the best interests of a company’s customers or shareholders in mind.

The problems

Bonuses should be paid for services rendered. Outside listed company executive teams, bonuses are nearly always the result of past performance, but this is rarely the case for ASX-listed companies. Instead, complicated and opaque scorecards are used to determine both a short-term incentive and a long-term incentive. These are then ‘paid’ to executives based on equally complex, and often flawed, vesting conditions.

We regularly hear feedback that management places little value on the long-term portion of their remuneration, given the difficulty in understanding the structure of the reward 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.

The above has resulted in remuneration structures that are the antithesis of what we expect and what shareholders deserve. They are complex with hard to understand hurdles and vesting conditions, short-term weighted, asymmetrical and not aligned with shareholders given their high proportion of cash. We propose a new structure to address this.


Five keys to successful remuneration

We believe a successful remuneration structure should contain the following five attributes, listed below along with examples of how they could be applied:

1. Simple and transparent

Replace short-term incentives and long-term incentives with a single bonus scheme, such as an Executive Incentive Plan (EIP). An EIP is a payment in shares (after paying income tax on the bonus amount). This eliminates short-term cash bonuses, makes the system easier for management to understand, and minimises the number of remuneration structures on which shareholders vote. Structured well, management are appropriately rewarded only for good long-term decisions.

2. Long-term focused

EIP shares purchased are placed in trust for at least three years, but preferably five years (even if that exceeds the executive’s employment term). Ideally, the term should align with the company’s natural capital investment cycle.

Australian corporate history is littered with the kitchen-sinking of a company’s finances when new executives take the helm.

The ills of poorly executed corporate strategy often only manifest themselves years later and then often only with the benefit of fresh eyes. It is only fair that departing management share in the fruits (or problems) of their long-term decisions after they leave the company.

3. Symmetrical

EIP awards are free of ALL vesting requirements. Bonuses are paid for services rendered and are therefore already earned. Future vesting hurdles, which are unnecessarily complex and less important when the awards are used to buy shares (see point four below), should be abolished.

4. Aligned with shareholders’ interests

The after-tax bonus amount is invested in shares in the company, not paid in cash. These shares are purchased on market rather than being issued by the company.

These shares will rank equally with all paid-up shares in issue – they will carry votes, receive dividends and, importantly, their value will rise and fall with the market. Poor decisions, or badly executed corporate strategy, will likely see a company’s share price fall and along with it, the value of this award. Consequently, despite the award being free of vesting hurdles, outcomes will still be aligned shareholders’ interests.

Its simplicity will save significant costs (tax consultants and accountants tasked with approving and monitoring complicated schemes) currently borne by shareholders.

5. Quantum and fairness

In this article we have not focused on how much executives should be paid, but instead on the form in which that payment should be made.

Addressing the structure of an EIP award remains the responsibility of each company’s board. Having the awards ‘paid’ in shares alleviates some of the risks around poorly constructed KPIs used to arrive at EIP award amounts, but it does not eliminate them. There is no cookie-cutter approach to setting ‘quantum-determining KPIs’.

Not all the apples are rotten

While our proposal to restructure remuneration may seem somewhat different from the norm, we are starting to see some take-up by management. Woodside, Wesfarmers, QBE and AMP are all large Australian companies that have made changes to their remuneration structures in recent years, often including some of the measures we suggested (although we should be clear that this is not always due to our influence). We think this makes a lot of sense and hopefully it is a trend that will continue.

For a long time many CEOs have been well rewarded for a mediocre or poor job. This is not right for the company’s shareholders, or their customers. Adopting a fairer, more consistent system that rewards long-term performance will benefit shareholders and businesses alike.


Further insights

Going against human instinct and taking a contrarian approach to investing is not for everyone, however there can be great rewards for the patient investor who embraces Allan Gray’s approach. Find out more 


Simon Mawhinney
Managing Director and Chief Investment Officer
Allan Gray

Simon joined Allan Gray in 2006 as an analyst. Before this, he was at Alliance Berstein, Macquarie Bank, and Deloitte and Touche. Simon has a Bachelor of Business Science with first-class honours (majoring in finance and business strategy) and a...

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