Executive salary caps are a red herring

Reflections on AICD seminar: ‘Directing Tomorrow Today’

The Australian Institute of Company Directors (AICD) has over 23,000 members, but fewer than 140 CEOs earn more than 10 times the average salary according to the Productivity Commission. Why should the other 22,860 members support AICD efforts to oppose government legislation on salary caps for executive pay? Does the AICD only represent the top 150 ASX companies or are directors simply out of touch? (and I am one of them!)

You cannot blame the government for trying to curb the excesses that lead us into the GFC. It was inevitable new legislation would be introduced. The public are angry and now that the economy is starting to recover, they expect something to be done.

Since the beginning of this year I have been urging boards and their management teams to be proactive and not wait for knee-jerk legislation (Preparing directors for the governance backlash). Anyone can make a mistake and we needed to restore confidence. We needed to show the public we can be trusted to self regulate and effectively govern the things that really matter. Recent AICD seminars on ‘Directing Tomorrow Today’ raised the question for me of whether we have the stomach to do the job.

Two statistics highlight the issue: (a) 60-75% of business failures are due to managerial incompetence[i], (b) 50-67% of all project investments deliver no business benefits whatsoever[ii]. Projects matter because they are the primary way of delivering strategy. I haven’t met anyone [yet] who deliberately sets out to fail yet these statistics are endemic. The problem relates to managerial over-optimism [iii] and surely it is the board that has to take overall responsibility to see it is addressed.

The AICD oppose legislation on remuneration because it is a primary role of the board to ensure risk is aligned to reward (and their implication is that additional legislation is unnecessary). However, the problem is a lot older than the GFC, there has been no shortage of advice pointing to the right direction (How much governance is enough?). During the AICD seminar the discussion focused on the appointment of the CEO and how they would be remunerated, but failed to recognise the problem needs to be dealt with at more than the CEO level. Boards need to implement workable solutions to ensure risk is matched to reward for all strategic initiatives and intercede often enough to ensure their managerial team deliver what they promise. There is even an Australian Standard providing guidance on how to do this: AS8016, HB280.

So the new legislation on executive remuneration, in my opinion, is a red herring. Our inaction has forced the government’s hand to do something. Are we our own worst enemy in not being able to self regulate on the things that actually matter?

Let me repeat some advice offered at the beginning of this year:

  • Following the GFC – governance practices will almost certainly be questioned
  • New governance requirements are likely to be introduced
    • Historically new requirements are introduced reactively
    • There is a risk new requirements will not add value
  • We should anticipate these developments
    • It takes longer for management to respond than for the board to ask
    • We should identify the key areas that need to be governed
    • We should check we have effective systems to monitor the key areas, and introduce new mechanisms where necessary
    • Governing major projects is one area worthy of attention
    • New Standards AS8016, HB280 have much to offer.

[i] M Van Vugt, “Follow me,” New Scientist 198 (2008): 42-45

[ii] R. Young, “What is the ROI for IT Project Governance? Engaging the board and top management.,” in 2006 IT Governance International Conference (Auckland, New Zealand, 2006)

[iii] D Lovallo and D Kahneman, “Delusions of success: how optimism undermines executive’s decisions,” Harvard Business Review 81, no. 7 (2003)

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