CEO pay and share prices; a love/hate story. The top 1% of the top 1% / by Adam Howard


Economic Update

Last week’s Update finished with a question about whether the top 10 highest paid CEOs in corporate Australian provided value for money. Given two of the CEOs on the list were only there as they happened to receive big departure payouts I have removed them and included in their place Ian Narev from CommBank and Peter Coleman from Woodside Petroleum.

That way we have 3 of the Big Four represented, plus some extra local flavour included.

I also thought it might be interesting to see what had happened over the longer term, perhaps 7 years, as a 12 month timeframe can be misleading, particularly as the 12 months to 30 June 2014 could potentially be termed a “bull market”.

Why 7 years? Well, the GFC began in late 2007 and up until that point the Australian Stock Market had also been experiencing a relatively sustained bull market as well. It made intuitive sense to compare prices at the end of similarly strong markets.

Now the point needs to be made that not all these CEOs were at the helm in 2007, but that’s irrelevant.

Do you know why?

Because there has never been a study conducted into empirically measuring the impact of a CEO’s performance on share price….

What the….? Surely someone has looked into whether, if your CEO does a better job, your share price will outperform the market.

That’s what the defenders of the CEO faith say in the media isn’t it?

“We need to pay CEO’s competitive salaries to attract world class talent.”

“World class CEOs generate more shareholder value, which is worth paying for.”

But there is no empirical (scientific, data driven) information proving a link between better CEO performance and share price performance, or a medium to long term increase in shareholder value. Here’s the real kicker though, there are empirical studies showing a very strong correlation between equity market performance and CEO remuneration. So, am I right in saying the following?

“We need to create more shareholder value in order to pay our CEO more.”

That’s the way it seems.

But wait, there’s more…

There is actually evidence that linking CEO’s incentive pay to equity market performance actually has a NEGATIVE impact on medium to long term share prices! I am sure you can guess why. High pay creates overconfidence, and overconfidence leads to poor decision making and excessive risk taking. Excessive risk taking with money that isn’t yours. 

And yet in 2010 and 2011 both Rio Tinto and BHP Billiton amended their senior executives’ remuneration guidelines to include a substantial weighting for performance against an index of equity market prices. Final point; studies have also shown that CEO remuneration is highly correlated with equity market performance but without the downside effects

This sounds like a theme I might have mentioned previously. When a company shoots the lights out it’s all the CEO’s doing, but if it tanks it’s not his fault. I usually try to mask my opinion here, but in this instance I guess it’s a little obvious. I think CEOs are overpaid and have short planning horizons. But I am not alone, with some studies I looked at listing some considerations that should be included in considering the appropriateness of CEO pay.

These included:
Does the business require a CEO with a globally competitive salary?
Does the company’s complexity match its market capitalisation?
Do short term incentive payments actually represent a challenge or is the CEO just getting 
paid for coming to work?
Do performance targets;
Include total shareholder return vs the wider market?
Consider the industry in which a company operates?
Consider the maturity of that market?
Encourage excessive leverage or risk taking?

So, what do we think about these issues in the context of the following list? 

A little explanation. Green means the share price outperformed the ASX 200, and red means it didn’t. Over the past 12 months 8 out of 10 company’s share prices outperformed the index, which I would expect, but over the longer term that dropped to 5. I think it’s clear that the 5 who exceeded index performance did so substantially, but was it the CEO’s brilliance that led to that outcome? 

Well, the banks’ share prices crashed spectacularly following the GFC, with real concerns about the strength and liquidity of banks worldwide. But then the Federal Government provided the banks with an explicit guarantee, lowering their cost of capital, and all four banks squeezed out their bad debtors and kept those debtors’ capital, strengthening their balance sheets. 

In fact, ANZ’s Mike Smith has been pursuing his Asian expansion strategy for at least the past 5 years, and this is reaping rewards, but this has had little or no impact on share price, with ANZ trading at or close to the same price per share as Westpac and NAB.

What about Telstra? It had always been an underperformer and had been taken to the brink by ex CEO Sol Trujilo so Telstra was starting from a low base. Revenue and profits appear to have improved as a result of a renewed focus on customer service and an increased retail presence, as well as a better suite of products.

Without being an expert, it appears Thodey’s strategy may have had a substantial impact. The only company in the top 10 where the CEO’s actions appear to have had a clear impact on share price is Amcor. Amcor, based in Melbourne, is the world’s largest manufacturer of packaging and its current CEO Ken McKenzie has been in the chair 9 years and appears not to have put a foot wrong. He followed on from a CEO who left in disgrace after Russell Jones was told to leave by the Board due to accusations of price fixing activity.

Always good to follow a mug as you look like a star. Never good to follow a star as you look like a mug. 

McKenzie has then used a series of international acquisitions to grow Amcor to its current size, while also improving its environmental and safety record. That’s impressive, and yet almost no-one would have heard of him. 

So, in summary, one CEO of the top 10 appears to have had a clear strategy, implemented it, improved his company’s position and performance substantially, seen the share price rise dramatically and been rewarded for it. To me that all seems strange, and more than a little perverse.  

From a CEO’s perspective it must be frustrating to know it’s almost impossible to gauge what impact your actions will have on share price, and that it’s really up to the wider market of investors to decide if they like the stock or not. At least, if you are a talented CEO it must be frustrating. 

If you are an ordinary CEO it must be quite comforting, as you know your remuneration is going to largely follow the direction of the market index, except when it goes down of course, with little or no reference to your own company’s share price. 

Here’s another table comparing the average CEO salary, average worker’s salary and the year-end ASX 200 index value for the years 2001 to 2010. What do you think about this?

Over the same period, inflation was 29%.

Like I said, awesome if you are a CEO.

Now, a couple of caveats. First, the above numbers for average CEO salaries are the base salary only and don’t include shares or  options granted as part of any short or long term performance incentive payments, which is why they appear low compared with those in the first table. 

The second caveat is, I am not a unionist, Marxist, communist, or any other type of ‘ist. I like capitalism, find it interesting and think it has been largely responsible for the sharp uplift in living standards enjoyed by a lot of the world’s population over the past 300 years. 

What I am is an advocate for the self-employed businessperson, the entrepreneur, the person able to have an idea, see an opportunity and execute and make money in the process. What I have a problem with is a class of employee positioning themselves to extract far more than their share of company profits. 

What got me thinking about this was an article I read regarding the explosion in inequality in western societies over the past 20 years. I think most people will be familiar with the family of statistics regarding the exploding wealth of the top 1% of the population, whether that be in the USA, Australia, the UK or any western nation.  

Joseph Stiglitz, Nobel Laureate and ex World Bank Chief Economist penned a book The Price of  Inequality outlining the impacts of this phenomenon. Thomas Piketty’s Capital in the 21st Century also pulled it apart. Even the rich got in on the act with US billionaire Nick Hanauer writing an article to his fellow billionaires titled The Pitchforks are Coming, warning them of the French Revolution style wave of discontent amongst the working poor and the dangers posed by their hubris. 

Well, I thought rather than wax lyrical first, I would just drop in some nice graphs. Now, noted this is US data, but I am using it as a reliable sample set and inferring that a similar wealth divide is occurring in Australia. The first graph is a song we all know, the rich getting richer and the poor get the picture.  

But, wait, what’s this? The rich aren’t getting richer? Only the super-rich are getting richer. 

So, the top 0.01% of the US has quadrupled its wealth in 50 years. Not bad work if you can get it. 

What about Australia? Apparently we are the 11th most unequal of the 34 OECD nations, or we were in 2011. The bad news is the Australian Bureau of Statistics does not split its sample by single percentage points, but by 20% blocks. According to the ABS Australia’s net wealth is $7.2 Trillion with the top 20% holding 60% of that, or $4.3 Trillion. 

According to a nameless research fellow at the Melbourne Institute of Applied Economic and Social Research, entry into the top 1% requires net wealth of a little over $5 Million. If that’s the case then the range of net wealth within the top 1% is enormous, from a little over $5 Million, to last year’s wealthiest at $18 Billion, Gina Rinehart. 

Now, given the earnings figures in the first table in this week’s Update it’s also fairly obvious that all our top CEOs will make it into the top 1% as well. And that’s where I get annoyed. If it is your company and you started it, think Lindsay Fox, Gerry Harvey, Kerry Stokes, et cetera and you are still the CEO then that’s fine. But if you are just looking after other people’s money, then I’m not so sure.

Food for thought….