Executive pay. As the globe struggles to emerge from the worst recession since the 1930s, it is one of the hottest topics under debate. Did excessive remuneration cause unnecessary risk taking, particularly among investment bankers, and did that lead to the current crisis? Should executive compensation be subject to some form of regulation? How should corporate boards approach this topic? In a two-part article, Directorship’s Chris Gibbons examines where South Africa’s top players fit into the picture and how boards should go about linking risk and reward.

Did remuneration structures contribute to the recent asset bubbles and the recession that erupted when they failed? PricewaterhouseCoopers’ Southern Africa CEO, Suresh Kana, sets the stage: “To some, it is strongly believed that the level of rewards and the culture that created them was one of the most important contributing factors, whilst to others, they played little or no substantive role.” He is not being ambivalent: there are genuinely two very distinct schools of opinion. Take this recent exchange from a Harvard Business Ideacast, entitled ‘Is Executive Compensation Broken?’

On one side of the divide is Ira Kay, Global Practice Director of Executive Compensation Consulting, at Watson Wyatt Worldwide and author of The Myths and Realities of Executive Pay: “No, executive compensation is not broken. There is no evidence that it is broken, nor that it caused the current crisis. Does CEO pay move up and down with the stock market? Yes – and it recently went down substantially.”

Opposing him is Anne Sheehan, Director of Corporate Governance for the California State Teachers Retirement System, one of the largest pension funds in the US: “The model is broken – public trust, public outrage over executive compensation is something that needs to be addressed…. Whether it was at the executive level or at board level, it was the executives who were responsible for the actions of the people in the organisation.”

Neither Kay nor Sheehan backs down, endorsing Kana’s view that ‘what is certain is that it has created significant scrutiny around compensation in the financial services sector, particularly from regulators around the world. Hence there is consensus that some degree of reform to reward systems would be beneficial. However, there is less consensus about the scale of the change required and about what, if anything.’

Giles Robinson, MD of Hay Group, the global human resource consulting organisation, points to the politics of this issue in the US: “In the minds of the US regulators the asset bubble has resulted in excesses in terms of executive pay. This is demonstrated by the contemplation of a bill that, if passed, would regulate pay at all listed firms and allow for assessment of whether pay practices encourage risktaking – especially at financial institutions.”

SA lags the world
But what about South Africa? Robinson thinks that the “more modest stance on executive pay in SA may have had an effect on executives not taking excessive risk, but it is clearly not the only factor.” “As I see it,” he says, “the Credit Act and foreign exchange controls, among other regulations, had a more direct impact on SA being somewhat cloistered from taking on high-risk credit.” Kana, too, notes that our “financial services industry is in much better shape than in many other jurisdictions… however this does not mean that SA is not also in need of reform. This is evident in the recommendations in King III.”

With that as a background, the starting point for an assessment has to be whether or not local executives, particularly the CEO, are fairly paid or not. Chris van Tonder, managing partner of executive search consultants, Interconsilium, says he thinks that they are, and he reminds us that “most of the talk about remuneration on a grand scale was created by Wall Street and in the UK and was mainly in financial services. I don’t think industrial services or the mining industry or any of those more down-to-earth companies have ever had a problem. On a rand-for-pounds basis, South African executives are still very low on the scale, but if you take the buying power of what people here are paid, then it is not too bad.”

Madge Gibson, a partner at Jack Hammer Executive Headhunters, says there is no definitive answer to the question, as remuneration across companies, let alone industries, varies enormously. “On average, I believe South Africa’s top executives are fairly remunerated for the level of expertise they provide and the amount of responsibility they shoulder. There are unspoken financial ‘parameters’ which the majority of senior executives fall within.”

Bankers can bank on it
Hay Group’s Robinson says it is a difficult question to evaluate because it depends on which criteria are used. “Most remuneration committees will use something that is called ‘market-related’ and the problem with market-related is what are the relationships? Should somebody like Jacko Maree in a very big organisation like Standard Bank be paid the same as somebody in a much smaller organisation or bank? You have to get some sort of relationship of size… and you also have to take into account the complexity of the business. Top South African CEOs,” says Robinson, “will operate in a band between R8m and R12m p.a. but in comparison with other countries, we are very moderate.”

Van Tonder says the banking sector ‘is still by far the best remunerated’, a position endorsed by Gibson, but she adds that ‘government sectors tend to pay highly, as do listed companies. The financial services industries have been notorious for their large payouts during boom times, but this is most certainly changing and under intense scrutiny.’

Someone who takes a very different view is Dr. Linda Ronnie, Senior Lecturer in Organisational Behaviour and People Management at UCT’s Graduate School of Business. “I definitely lean towards the view that South African CEOs are excessively remunerated in the context of the South African economy. What kind of example is leadership setting in this country – and I’m thinking about leadership generally, across both the public and private sector.” Ronnie believes that leaders should adopt the values they are espousing and that is where the salary gap doesn’t sit well. “You’re espousing belttightening, cut-backs, restructuring, and your enacted values are completely at odds with this; there’s a disjuncture between the two and that’s what employees see.”

Things ain’t ‘wot they used to be!
The global recession has forced companies to cut costs; are we also seeing downward pressure on salaries? Jack Hammer’s Gibson says definitely: “Most companies are focused on reducing costs and are sensitive to the effects of the recession on their bottom line and of reporting losses to their shareholders. Across the board, we are seeing restraint in cost-to-company offerings, as well as reductions in bonus components; in fact, in some cases bonuses are no longer guaranteed or even implied.” Hay Group’s Robinson agrees to an extent: “Local companies are not being affected, and they are still processing salary increases. But international organisations – particularly US and European multinationals - have put a freeze on salary adjustments and bonuses are being affected by that.”

One critical gap appears to exist between the CEO and his or her fellow directors. According to Robinson, it is most pronounced in the US, where a CEO would typically earn around five times the amount of board-level colleagues; in SA the figure is roughly double, although when you look at bonus and share schemes there is a huge differential between the two tiers. Gibson agrees: “If we look across a mix sectors, including banking, insurance, retail, FMCG and telecoms, in extreme cases there are CEOs earning packages which appear to be over 50% higher than those of their co-directors.”

The root cause of this problem, explains Robinson, is the proximity of the CEO to the Board’s Remuneration Committee. “Is the RemCo really able to make independent decisions when they are going to go and play a round of golf together later? The differential between the CEO and the next tier indicates that, and also that RemCos are looking at the CEO rather than the top team.
That’s one of the criticisms that I would make against RemCos currently – they are not really looking at whether the team is performing together.”

Government intervention?
So, should government policy-makers intervene in executive remuneration, through caps on either salaries or bonuses? Linda Ronnie says no: “I am against that. It’s too simplistic to say ‘right, we’ll cap executives’ salaries.’ Really? Who’s going to enforce that sort of thing? And is it desirable? The discussion needs to come from linking pay and performance.” PricewaterhouseCoopers’ Kana notes that many regulators around the world have already moved to intervene in executive remuneration, ‘but in almost all cases there is no question of capping other than in the case of government bailout – the regulators have simply proposed best practice guidelines for reporting and disclosing executive compensation.’ Referring to bonus caps in the UK, Interconsilium’s van Tonder says, “The move is very short sighted. People will leave the moment the economy starts improving and opportunities arise.”

Hay Group’s Robinson says that there needs to be a more balanced approach to how incentives are derived. “There should be not one criterion for incentives, but several, almost like a balanced scorecard. You would also look at longerterm incentives, rather than putting all your incentives in one basket. Rather say ‘if these elements come together and there is long-term wealth creation for shareholders, then you will benefit out of it.’ This approach, with a wider spread of criteria and a longer term view, encourages smarter risk taking.”