Further to my submission to the Productivity Commission Review of Executive Remuneration, I spoke to my submission on the 24th June 2009. Below is a synposis of my presentation.

My consulting experience has given me insight into the perspectives of shareholders, boards, CEOs, executive teams, and from the "bottom" of the organisation. I've been appalled at what

I’ve seen:
a. The generally poor quality of Board and management’s decision making – despite some outstanding exceptions and despite the best intentions.
b. Managerial subjectivity and its profound affect on shareholder benefit.
c. That shareholder are generally “powerless” to change the status quo relating to their investments.
d. Management is generally oblivious to, and disinterested in, the impacts of their decisions on shareholders.
e. 1980-90s experience and corporate collapses and malfeasance. The current financial collapse has underscored my comcern and lifted the scale of losses to another realm.

This caused me to take interest in the relationship between management and shareholders.

The issue of executive remuneration, as important as it is, is “merely” a symptom of a much bigger problem: that problem is, the way executive managers and directors relate to their shareholders or owners.

In the context of corporate activity, and based on my observations and research over many years, executive remuneration, as an issue, pales into insignificance compared to the hundreds of billions of dollars of shareholder funds wasted through managerial subjectivity, incompetence, poor judgement, ill conceived pursuit of guru theories, pursuit of executive managers’ personal agenda, misguided assumptions and inadequate corporate oversight and accountability. All of that despite management’s generally honest endeavours to “to do the right thing.”

Unless you rectify the core problem, executive remuneration changes will never achieve much to protect shareholders’ interests.

It is for that reason my submission is focussed on the Terms of Reference (TOR 4) item related to the relationship between the corporation and its shareholder: interestingly, also the topic of my doctorate research some years ago.

As long as directors and managers are free to define the outcomes of the organisation they manage, then shareholders will nearly always come off second or even third or fourth best.

Managers decide the projects that the corporation invests in, the initiatives they will undertake, the markets they will play in, the tools they will use, the philosophies they will adopt, and the corporation’s remuneration policy.

In other words, management determines how resources will be applied, what the organisation will generate, what benefit the owners of the business will secure, if any, and how they themselves will get paid.

All of these decisions commit the organisation to significant costs, and often, significant risk.

And these business costs are costs borne by owners and the business risk is also largely borne by owners. They are not costs or risks borne by management who initiate those costs and risks.

Some of these decisions focus on shareholder outcomes, but unfortunately, many do not.

More relevant still, managers determine the performance criteria against which they will be assessed and by which they will be rewarded.

This stems from a belief that the corporation, because of its legal status, is a separate entity from its owners i.e. the Social Entity view of the corporation.

This view argues that only managers and directors can determine corporate objectives. This view is arguably a significant part of the cause of the current financial collapse and a large part of the executive remuneration excesses.

Instead, directors and managers must understand that, despite the legal status of the corporation, they are nevertheless agents of the owners – and not the owners themselves.

Managers must apply their efforts toward the optimisation of shareholder objectives – that is their job and that is what they are paid to do – and that is the fundamental purpose of the corporation.

Critically, ONLY by knowing its shareholder objectives (i.e. its metrics – value, benefit, growth and risk), can an organisation align its activities toward their fulfilment.

Corporations currently make assumptions about their shareholder objectives that are demonstrably, logically and intuitively wrong.

These assumptions form the basis of performance management and therefore remuneration.

As examples of such erroneous assumptions, this research has found that:

• All shareholders do not have the same objectives
• A shareholder may have different objectives for different investments
• Institutions are not a proxy for small investors
• Shareholder objectives when known, will form a bell-shaped curve along each dimension of value, benefit, growth and risk
• Management assumes it knows what it is that shareholders want and they act on that assumption – but they don’t know without asking – and no one asks.
• Shareholders cannot run the company but they can and should define its outcomes: i.e. board interpreted shareholder metrics based on value, benefit, growth and risk – and what they want becomes the corporation’s Mission.

If one rejects this Social Entity view and replaces it with one that aligns the purpose of a corporation to the satisfaction of its shareholders’ objectives (the “Property” view), then a range of benefits are derived.

Some of these benefits include:

A strategy based on the market rewarding those organisations that are more focussed on delivery of shareholder objectives (metrics). Therefore, since you engender the behaviour you measure, a sane remuneration policy would dictate that the ONLY way for an executive to enhance his personal wealth is by exceeding shareholder expectations.

The way to do this is twofold (hence my recommendations):

a. Insist that all listed companies publish their shareholder metrics (value, benefit, growth and risk) in their annual reports;

b. For the government to facilitate and/or encourage the establishment of a Shareholder or Owner Accreditation Certification that would see listed companies seek accreditation on 4 sequential levels:

• First Level: Having established their shareholders’ metrics
• Second: Having embedded their shareholder metrics (as interpreted by the Board) into their Mission Statement
• Third: Having embedded the metrics into the corporation’s planning methodology (top-down - as defined in my submission)
• Fourth: Having demonstrated that corporate outcomes have delivered shareholder metrics

c. An organisation that is fully certified, offers existing shareholders greater certainty, potential investors and bankers lower risk. It also provides management with clarity and eliminates ambiguity regarding “shareholder satisfaction”. It therefore makes the management task easier.

Other benefits include:

1. Provides improved and focussed corporate, strategic and market planning systems as outlined in the submission. “If it doesn’t contribute to core metrics – don’t do it!”
2. Provides significant control over the negative impacts of managerial subjectivity.
3. Encourages a rational performance management system built around shareholder metrics rather than industry ratios. (Managerial career versus shareholder interests).
   Based on my research, I am of the view that the only legitimate corporate performance measure is the ability of a corporation to deliver its shareholders’ metrics.
4. Improves resource management and utilisation.
5. Facilitates a rejection of guru theories and “management flavours of the month” that don’t demonstrably contribute to specific shareholder-based outcomes.
6. Lastly, it contextualises stakeholder issues: no organisation exists for its non-owner stakeholders, but those stakeholders must be managed in a way that enables shareholders to “secure satisfaction.”
   It therefore minimises wasted shareholder funds relating to corporate, community and managers’ private activities that aren’t related to shareholder interests.
   If society or the government want corporations to become social change agents – then legislate for it and allow all corporations to operate on a level playing field. Otherwise, managerial subjectivity and self-interest spends owners’ funds on non-essential activities.
7. In relation to remuneration, rewards must be fair and reasonable for the effort applied to achieve required outcomes and shouldn’t, within reason, stifle personal ambition, motivation or free enterprise.
8. Provided the organisation is aligned to its shareholders, and shareholders have approved the remuneration policy and structure, then the Board should be able to pay executives whatever it takes, and is reasonable, to deliver the required outcomes. BUT the Board must be held accountable to its shareholders for those decisions.
9. Furthermore, any major attempt to interfere with the free market has the potential to cause major corporate disruption, market anomalies, distortions and manipulations.
10. Reasonable bonuses to reward executives for exceptional performance are acceptable – provided:
    · the organisation is aligned to its shareholders’ benefit; and
    · the bonus is ONLY based on exceeding shareholder metrics and not for any other measurement (particularly any management-derived goal or indicator or enabler, such as TQM, Innovation, or product concoction, etc (KPO versus KPI);
11. The role of directors is to interpret its shareholder metrics and to set corporate objectives, (i.e. the corporation’s Mission) and therefore to set the performance criteria against which management will be rewarded.
12. It is not practical or reasonable for shareholders to approve executive remuneration, except through the approval of a remuneration structure or philosophy that is applied and enforced by the board and for which the Board is held responsible.
13. Furthermore, even the best corporate governance disciplines will not ensure shareholder “satisfaction” in the same way that Quality Accreditation will not stop a disastrous product from being developed. Both are important but both are merely processes and don’t affect the core issues – what is the outcome that is required of the corporation.
14. One can’t enforce CEO/Exec remuneration as a multiple of bottom or average salary because “context dictates value”. Executives are generally smart and many will pursue self-interest knowing that average CEO life span is only 3-5 years in the one organisation. If you attempt to regulate remuneration, then executive focus will shift to personal gain and away from those things they are being paid for. (Management may restructure the bottom of the organisation to engineer the remuneration algorithm it wants, e.g. outsource or form into separate company.)
15. The corporation / Board must be able to modify remuneration arrangement under certain circumstances. The triggers for such reviews should be embedded in the employment agreement (e.g. major economic change, natural catastrophe, acquisitions, divestitures, takeovers, etc).
16. Golden parachutes should be constrained, if not banned altogether. If a parachute blocks an initiative that benefits shareholders (such as in a sale or divesture) then the parachute should be deemed as voided. Shareholders should not be constrained from dealing their asset provided it is within the law and regulations.
17. The concept of holding bonuses in trust for a given period (e.g. 18 month) is inappropriate if the corporation is aligned to shareholder metrics and the bonuses have been earned in exceeding those metrics.
    But if the corporation is not aligned to shareholder metrics, (i.e. not Owner Accredited) then holding bonuses in trust for a period is an idea that has merit and should be considered.
    Therefore, if executives are keen on “immediate” bonus rewards, then they will help ensure the organisation is shareholder-centred and will focus their own efforts on exceeding those shareholder metrics. In this way, both the executive wins and the shareholder wins.
    

In summary then, if you don’t fix and realign the relationship between the corporation and its shareholders, then tweaking executive remuneration will make little difference to the business owners, and may even harm them.