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Pig of a year for the overpaid

Thanks to new legislation, shareholders now have a mechanism to punish the executives of companies they believe are paying themselves excessive remuneration, writes David Potts.

Thanks to new legislation, shareholders now have a mechanism to punish the executives of companies they believe are paying themselves excessive remuneration, writes David Potts.

It's payback time for executive pay. The troops are getting restless and they're armed. This is the first annual general meeting (AGM) season where shareholders can shoot down pay rises.

Well, it takes three shots but the point is the pay of the chief executive and directors must now be approved by shareholders.

Nor will they be allowed to vote on their own pay and so won't be able to outgun shareholders by flourishing proxy votes nobody else gets to see.

In the past decade, returns from the sharemarket - capital gains and dividends - have doubled but the median pay of the top brass of the top 100 stocks has soared 138 per cent to $4.4 million a year.

Cripes, your typical top 100 company executive makes more in a year than others will in a lifetime.

Not helpful was the let-them-eat-cake comment of former BHP chairman and NAB CEO Don Argus who, in releasing an Australian Institute of Company Directors' (a sort of trade union for boards) report criticising proxy advisers, said shareholders who don't like executive pay levels "can sell the shares - it's as simple as that".

Gee, thanks. Ripped off by those who are supposed to be looking after your interests and then you're supposed to take it on the chin again by selling your shares at a likely loss.

Speaking of which, wasn't it the same Don Argus who wiped $2 billion from shareholders' equity with NAB's disastrous foray into the US?

Anyway, there's no proof that a highly paid CEO will deliver a better return for shareholders.

At least among the top 100, the lowest paid CEOs delivered more.

Pay rises at the top have easily outstripped the return to shareholders (which, thanks to the state of the market, was negative in most cases) and just about everybody else in the past three years.

The exceptions were relatively low-paid executives, though they tend to have a big shareholding, such as Fortescue's Andrew Forrest and Harvey Norman's Gerry Harvey, a study by the Australian Council of Super Investors (ACSI) shows.

A sign of the shareholder revolt is that last week there were so many hits on the website of the Australian Shareholders Association (ASA) that it crashed for the first time.

People power

Under the new "two strikes rule", a 25 per cent vote against the remuneration report at two successive AGMs will force a vote on the whole board.

OK, it's true that 90 per cent of shareholders could vote against a CEO's pay rise this year and it would count for little apart from leaving the board blushing, or at least you'd hope so.

Still, directors are getting nervous. The ASA says more corporate chairmen are willing to talk to it.

Boards have reason to be worried. Citi went back over the AGMs of the past three years and found that had the rule been operating then, Qantas and Rio Tinto would have been pinged on their pay policies.

Qantas is under fire from the unions as well as shareholders who have lost their dividend over chief executive Alan Joyce's pay jumping from $2.9 million to $5 million.

It might have done a lot of silly things lately but, as you'll see in a moment, Joyce's pay probably wasn't one of them.

Challenger (with what must be a record vote of 70 per cent against a remuneration report) and Transurban have had three strikes against them and presumably their boards would have been tossed out altogether.

Still, the fact that the votes had some effect even before the law was changed suggests most boards will do anything to avoid a first strike, let alone a second one.

But they still have some way to go. Among the top 50 or so companies, the average executive pay rise last financial year was reportedly about 9 per cent.

Did you get that? Neither did I.

That's way above the growth in wages or inflation - more than both combined, come to that - and usually more than the rise in profit.

Cash bonuses especially rankle with shareholders because they seem to be handed out irrespective of whether it was a good or bad year, let alone whether the CEO was performing.

But boards are getting sneakier. One way around a cash bonus is to pay in shares instead, which superficially looks more like an alignment of shareholders with management (but, in fact, has more to do with market sentiment than executive performance) and, better still, doesn't show up in the remuneration report.

"In the wake of the global financial crisis and regulatory and shareholder efforts to reduce the potential for executives to receive windfall gains in cash based on unsustainable performance, many large Australian companies, especially in the financial sector, have begun deferring significant proportions of annual bonuses into equity vesting over time," as ACSI puts it.

Equity bonuses are treated differently in the books. They have to be amortised, taking them out of the cash-flow statement and making the amount each year smaller.

It also means that the CEO might get more, or less, in any one year than his reported pay.

The good guys

Which brings me back to Qantas and its CEO.

Instead of a cash bonus, he's getting Qantas shares and at the rate they've been dropping, there won't be much left when he's allowed to sell them in two years.

Incidentally, shareholders have no say over individual cash bonuses, and while their approval is required for any new shares being issued, it's not if the company just goes in the market and buys them.

The Commonwealth Bank's retiring CEO, Ralph Norris, is also a victim, if that's the right word, of the switch from cash to equity.

He topped the pay league tables with a $16.2 million salary but in his last year it was only, again if that's the right word, half that partly due to the fall in the share price.

For all the flak he's copped as being the highest-paid CEO, in fact last year he took a pay cut, involuntary as it might have been, when earnings rose 19 per cent and shareholders got a 10 per cent dividend rise.

The Joyce and Norris cases are unusual, however. "The actual benefit received by the CEOs has been much larger, and much lower than that reported to shareholders," ACSI says.

Even so, some companies are underpaying their CEOs, based on gains in the share price and dividends, hard as that is to believe.

Citi compares their pay with what other CEOs of companies their size would have got based on what it calls the "anticipated relationship" with shareholder returns. The honour roll is Atlas Iron, Cochlear, Fortescue Metals, Iluka Resources, JB Hi-Fi, Macarthur Coal, Newcrest Mining, Origin Energy and Telstra.

A better way to pay

Oddly enough, returns to shareholders may not be the best way of measuring performance, especially when you're only looking at three years. A lot of things can influence the share price - such as takeover talk or a change in the industry - which have nothing to do with how the CEO is going.

So Citi then used the growth in earnings per share, which puts Asciano, for one, in a different light. It was savaged at last year's AGM, scoring a no vote of 41 per cent against the remuneration report over a $900,000 "signing and retention bonus" for the CEO, who had given up a possible $8 million severance package.

Other companies where the CEO is underpaid, relatively speaking, based on the three-year growth in their earnings per share were: Alumina, Boart Longyear (having been wrapped over the knuckles at the 2009 AGM), Macarthur Coal, Newcrest Mining, Transurban, Telstra and WorleyParsons.

On the even higher hurdle of a three-year growth in the return on equity, a tougher figure to manipulate, Citi says only three companies pass muster - Cochlear, Telstra and WorleyParsons. Whatever issues those three may have, executive pay isn't one of them.

But the ASA nominates AGL Energy for having the best executive pay policy, even though it was hit by a 29 per cent no vote last year, because it takes back bonuses of executives who don't perform.

"Incentives go in if the CEO performs and go backwards if he doesn't. That's a first. If AGL can do it, why not everybody else?" the chief executive of ASA, Vas Kolesnikoff, asks.

If there's only a tenuous link between the CEO's pay packet and the company's performance, this works in reverse too.

It's been hard to prove a company is doing badly because the CEO is overpaid.

No longer.

Research by Deutsche Bank, applying the results of a US study, has found an intriguing link between the CEO's slice of the pay of the top five executives and the share price.

The share prices of stocks where the CEO's slice was less than 20 per cent of the total executive pay did "quite significantly" better than the rest of the market, research analyst, Tim Jordan, says. More than 50 per cent and the company under-performed the market.

It was also more inclined "to make worse acquisition decisions" and "more likely to make opportunistically timed option grants to their CEOs", he says.

The good guys with ultra-low CEO pay slices are Ansell, Aquila Resources, AWB, AWE, Cudeco, Challenger (which must have learnt its lesson), David Jones, Flight Centre, Fortescue Metals, Fleetwood, Harvey Norman, iSOFT, Karoon Gas, Linc Energy, Mineral Resources, NAB, Prime Infrastructure, Perseus Mining, Rio Tinto, Roc Oil, Virgin Blue, White Energy and Whitehaven Coal.

Tricks not a treat for everyone

THE odds are so stacked against small shareholders at AGMs that even the Australian Shareholders' Association, which has seen just about every trick in the book, can be caught out.

It was one of the first in the season so perhaps that's why.

Anyway, Metcash, which owns IGA and Mitre 10, was able to take advantage of the corporate equivalent of federalism.

Perfectly legal and above board, except it disenfranchises shareholders.

Boards should reveal proxies before a vote is cast at an AGM. Unless, as in Metcash's case, the company's constitution says otherwise.

The chairman read out "the overwhelming number of proxies in favour of three of the five directors up for election" says the ASA's representative, Allan Goldin.

That seemed to clinch the vote that was passed on a show of hands. But it turned out the proxies against fell just shy of 25 per cent and had Goldin exercised the ones he held the no vote would have been 25.2 per cent, and Metcash rather than GUD Holdings would have had the ignominy of being the first to fall foul of the new two strikes rule.

Keep an eye on the books

WHETHER you go to an AGM or watch it on the internet, it pays to look at the annual report.

Go straight to the "consolidated statement of cash flows". It's only one page and shows everything that came in and went out of the business. It's harder to manipulate than the reported profit.

Check out the "net cash flow from operating activities", which will be near the bottom. It's the pre-tax profit less one-offs and book entries such as depreciation or goodwill.

It will also show whether the company has quietly borrowed more.

Next is the balance sheet, which can be easily dressed up. Tricks include a stopgap loan from a director to reduce the official debt level and manipulating inventories.

Then check out some key financial ratios. These may be mentioned in the footnotes or you can get them from a broker's website.

The debt-to-equity ratio is the company's debt divided by shareholders' equity (which is also called net assets).

The lower it is the better and you want the company to at least own more than it owes.

The return on equity is the net profit divided by shareholders' equity. This is one you need to watch over time to make sure it isn't falling.

In the notes look out for "related party transactions", which is accounting speak for eye openers.

Finally, at the back you'll find the major shareholders and how much skin the directors have in the game.


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