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Investors feel the pain while bosses enjoy the gains

Shareholders have a powerful new weapon in their hands to influence executive pay, but will they make it tougher for fat cats to skim off the corporate cream? Philip Wen and Ian McIlwraith report.

Shareholders have a powerful new weapon in their hands to influence executive pay, but will they make it tougher for fat cats to skim off the corporate cream? Philip Wen and Ian McIlwraith report.

When the boards of Australia's largest companies front their annual general meetings for their day of reckoning, they may find that their grey-haired armies of shareholders have an extra spring in their step.

AGM season is, after all, the one opportunity a year ordinary shareholders get to quiz the powerful directors of the companies in which they invest.

Invariably it is self-funded retirees, whose nest eggs are at stake, who attend in their droves vote for, or against, resolutions proposed by the board, then hobnob with directors over sandwiches and a cuppa. Corporate democracy in action.

However, this year's is shaping up to be an AGM season with a potent sting in the tail.

Non-binding votes on remuneration reports finally have some teeth. Hitherto investors could only make token protest votes against how much senior management and directors paid themselves.

Now, thanks to laws that took effect on July 1, shareholders can compel non-executive directors to face re-election if 25 per cent of investors vote against the remuneration report for two years in a row. And as investors helplessly watch their savings being pulverised in global markets, they might be tempted to exercise that right.

After all, this is the most powerful weapon handed to shareholders in 20 years of gradual reform that has lifted the veil on how and why board members and executives take home more money a year than most people earn in a lifetime.

"Shareholders will say: 'We know it's tough, we understand it's tough, but should we be the only ones who hurt? You still get bonuses ... whereas I only get my bonus when the sharemarket is performing well'," says Ann Byrne, the chief executive of the Australian Council of Super Investors (ACSI), which advises its members on corporate governance.

Matt Williams, the head of Australian equities at fund manager Perpetual Investments, says the new two-strikes' rule has unsettled chairmen and made them anxious about the potential consequences. "This is really the hot issue there's no doubt about it," he says.

Retail shareholders might fill the auditoriums at AGMs, but the real power often lies in the hands of the major shareholders, including institutional fund managers like Perpetual.

Companies are in constant dialogue with heavyweights like Perpetual, conscious that without their support a share price, or an issue of stock to raise more money, can be crushed.

As such, the outcome of an annual meeting vote (and even what appears on the agenda) is often decided before the event by proxy votes cast well in advance by institutional investors.

Williams welcomes the change and says it will help boards to focus on structuring pay deals that more closely align management with shareholders.

"I think this whole concept has been brought in because of the perception that this alignment [of executive remuneration and shareholder interests] has gotten out of whack - and I think there's a fair basis to that assessment," he says.

Companies might be bowing to demands for greater explanation and justification, but executive pay rises still seem to be running at rates that are higher than inflation.

An analysis by the Herald of company reports filed in recent months by most of the country's 100 biggest companies shows that the median increase in base pay for chief executives in the latest financial year was about 9 per cent - from $1.47 million to $1.6 million. Add in short-term cash bonuses and the package rises to $2.61 million.

Total remuneration - which includes notional valuations of long-term share-based rewards - showed a median fall of 1.3 per cent, from $3.57 million to $3.52 million in the latest financial year.

While executives may never receive some of those shares if they fail to clear certain performance hurdles, the fall in value is more a reflection of falling share prices than less generous grants to executives.

The Herald analysis differs from ACSI's annual chief executives' pay report in that it excludes superannuation, long-service leave and miscellaneous perks (for example, the use of a private company jet) disclosed in annual reports.

ACSI's report last year found that the median fixed pay of chief executives rose from $1.81 million to $1.82 million. (CEOs earn 131 per cent more than they did 10 years ago.) Only 10 per cent of chief executives in the ACSI report did not get a bonus last year.

The Commonwealth Bank's CEO Ralph Norris, vilified last year for his record $16.16 million pay in a year when the bank raised home mortgage rates above Reserve Bank increases in official rates, had his total pay cut to $8.64 million

this year.

This means the mantle of the highest-paid chief executive has reverted to the shopping centre mogul Frank Lowy (see story below). The Westfield chairman, who stood down as chief executive in May to make way for his sons, Stephen and Peter, was paid $15.96 million, comfortably topping the list ahead of Rio Tinto's Tom Albanese, who pocketed #8.36 million ($12.75 million) and ANZ's Mike Smith ($10.86 million). BHP Billiton's Marius Kloppers earned $US11.63 million ($10.84 million), while Westpac's Gail Kelly ($9.59 million) rounds out the top five.

In some cases, executives further down the totem pole than the chief executive have reaped the rewards of turning around an operation. The Coles chief executive Ian McLeod ($15.63 million) was paid more than twice as much money as his boss, the Wesfarmers' chief executive Richard Goyder, who earned $6.94 million.

Still, few could rival the golden handshake offered to the 34-year veteran of Leighton Holdings, Wal King, whose severance package could rise to $30 million, including a $12.6 million retirement benefit, and nearly $16 million in consultancy, non-compete and transition bonus payments.

Leighton will also have to dole out several other seven-figure payouts to other senior executives who have left during the year, including King's successor, David Stewart, who left suddenly after eight months in the job.

This, and the company's poor financial performance this year, has led some proxy advisers and analysts to predict that Leighton will come close to receiving a "strike" against its remuneration report, despite the German majority shareholder Hochtief - now controlled by the Spanish construction giant Grupo ACS - holding 54 per cent of

the votes.

The Herald's analysis, which takes in the pay details of more than 60 company chief executives (some are yet to file annual reports and others were excluded because they left or were appointed part-way through the year), indicates a growth in short-term cash-based remuneration as a proportion of total pay, possibly reflecting a rebalancing of pay as executives fail to meet their targets for long-term incentives due to poor earnings or share-price performance.

"There has been a slight trend in balancing the pay mix of some companies, either increasing fixed or reducing long-term incentives, or just increasing the short-term element," says Aaron Bertinetti, a director of proxy adviser CGI Glass Lewis.

Perpetual's Williams says this often happens when it becomes apparent that bonus hurdles become too hard to jump, whether through management's fault or because of tough economic conditions. "You do see, on occasion, the goalposts get shifted by some remuneration committees [on boards] to make it easier for management to achieve short-term [bonuses]," he says.

Bertinetti says high short-term bonuses have been a prevalent concern, particularly in the listed real estate investment trust (REIT) sector. This week,under pressure from fund managers before its AGM later this month, Stockland announced it would do a "comprehensive review" of its executive remuneration policies, which will result in the managing director Matthew Quinn's short-term bonus paid in shares rather than cash, and deferred for a number of years.

Bertinetti says short-term bonuses are also inappropriate for companies with a long-term investment horizon, such as miners and banks.

"We need to apply a lot of scrutiny on capital intensive companies," he says.

"I think short-term bonuses in retail probably makes sense, but not in some of the other [sectors] where you're investing billions of dollars over five to seven years in some cases." He says an adequate earnings-per-share hurdle, combined with a return-on-capital measure for bonuses, should ensure executives are appropriately motivated to strike the right balance between growth and shareholder return.

"We've seen many instances where companies just manage for the short-term profits, and the executives get their money and, lo and behold, they're out the door," he says.

"And its the next management's turn to come in and realise the business has been underinvested in, and for short term profitability. You see that too much and I think that's a key issue for boards at the moment."

You might get two strikes before you're out, but company chairmen are desperate to avoid the ignominy of receiving even one.

Predictably, the move has many corporate heavyweights up in arms, galled by the audacious prospect of losing their board seats so swiftly after earning them by dint of decades of senior management experience.

After the first strike, the next year's notice of annual meeting will automatically include a so-called board spill resolution. If a second strike is recorded, shareholders will vote to consider if they will reconvene within 90 days to depose the board.

Critics of the two-strikes' rule say the potential magnitude of the vote would prevent the big shareholders casting a vote against the remuneration report for fear of causing instability, and damaging the share price in the short term.

"I think a common issue of concern is that it leads to unnecessary board instability," says Will Moncrieff, a corporate governance expert at the Perth law firm Jackson McDonald, says. "It's using a sledgehammer to crack a nut."

Worse still, the rule could result in some unintended and unsavoury outcomes, Moncrieff adds, with some major shareholders potentially able to use a threat of a board spill to hold the company to ransom.

Bertinetti agrees that large shareholders could wield too much power in some cases.

"A concern for us and our clients is how those substantial shareholders and cornerstone investors - particularly sovereign wealth funds from overseas - will use that new power that they now have."

Bertinetti says the old non-binding vote was actually quite effective. Even when a remuneration report was voted down (by more than 50 per cent), it was very rare for shareholders to then vote more than between 10 per cent and 15 per cent against a relevant director at the same meeting, he says.

"So the reality is institutions always had the power to hold directors accountable for remuneration practices but they haven't actually exercised that power."

With higher stakes comes change, says Della Conroy, a remuneration consultant with PricewaterhouseCoopers.

She says there has been a big shift by boards to ensure greater transparency as to how remuneration decisions were arrived at, as well as a better effort to communicate those decisions to major shareholders.

She says the extra care has meant "a number of remuneration reports, redrafted several times" but the more intense focus has developed over a number of years because of requirements by the Australian Securities and Investments Commission, and reviews by the Productivity Commission and the federal government's Corporations and Markets Advisory Committee.

"This year there has been more time spent on [remuneration reports] but, again, I think that's an evolutionary thing, rather than a simple reaction to the two strikes," she says.

Bertinetti, however, believe it has dominated the consciousness of company directors tasked with developing remuneration policies.

"I think it's pretty front and centre [of their minds], unfortunately," he says. "I think that it's the biggest downfall of the law.

"The two-strikes' rule has basically added much more bite to remuneration, so that even more time is being spent on this issue - and, dare I say it - probably at the expense of more important issues."

However, Perpetual's Williams says executive remuneration is paramount as it goes to the heart of corporate culture and how a business is run.

"I think it's fundamental to how managements will behave," he says. "What gets rewarded will get done, I guess."

TOP 10 BEST-PAID CHIEF EXECUTIVES

Westfi eld

Frank

Lowy

$15.96m*

Rio Tinto

Tom

Albanese

$12.75m*

ANZ

Mike

Smith

$10.86m^

BHP

Marius

Kloppers

$10.84m

Westpac

Gail

Kelly

$9.59m^

Macquarie Group

Nicholas

Moore

$8.69m

CBA

Ralph

Norris

$8.64m^

Woodside

Don

Voelte

$7.77m*

NAB

Cameron

Clyne

$7.73m^

Crown

Rowen

Craigie

$7.71m

* YEAR ENDING DEC 31 2010 ^ YEAR ENDING SEP 30 2010

SOURCE: COMPANY REPORTS


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