In a pragmatic approach to the issue of executive remuneration, the executive remuneration packages could be determined according to organisational performance, as this would seem both logical and fair. Another consideration could also be the risk profile of the position, where the need for risk-taking associated with a position is rewarded. The value of everything in the economic world is determined by supply and demand in the market, which could be another determinant of executive remuneration. Determining this supply and demand can be left to remuneration consultants, who then, in turn, can recommend a package for the executive, which could be informed by market surveys. There are, however, factors in the micro- and macro-environment that would need consideration in the determination of
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executive remuneration packages, such as the organisational remuneration strategy and the socio-economic issues within the country. Below is a discussion of these seven determinants of executive remuneration, namely organisational performance, risk propensity, supply and demand in the labour market, market surveys, remuneration consultants, remuneration strategy, and socio-economic issues.
2.4.3.1 Organisational performance.
It seems apparent that organisational performance should be a prime measure or standard in the determination of remuneration packages at the executive level. It could be argued that the organisation performing well is in the interest of shareholders as well as the executive concerned, and, therefore, an alignment of interests between executive and shareholders is guaranteed. Perel (2003), however, believes that a major component of executive remuneration is unrelated to organisational performance. Nichols and Subramaniam (2001, p. 347) cite similar thinking by referring to Jensen and Murphy (1990b), who state that “the weight of the evidence points towards a small, almost inconsequential relationship between firm performance and CEO pay.”
This apparent lack of a relationship between organisational performance and executive remuneration is illustrated by Vignette A.
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Vignette A: Inconsequential relationship between firm performance and executive remuneration.
Vignette A illustrates that even though performance might be touted as an indicator of the level of executive remuneration, it is not what tends to happen in practice. On the contrary, the above vignette illustrates that there could even be an inverse relationship between organisational performance and the level of executive remuneration. Even if ‒ contrary to findings of research and newspaper articles ‒ organisational performance ought to be a good indicator of the efficacy of executive remuneration strategies, it raises concerns regarding the performance indicator. Would a downward turn in organisational performance be an indication of poor executive remuneration, or would it merely be a function of the prevailing economic climate, such as the current recession?
Another consideration to bear in mind is that, should organisational performance be a measure of executive remuneration, it would not necessarily satisfy the key element of the principal-agent relationship, namely alignment of the interests of executives and
Newspaper reports state that the Grindrod executive director received a R31.97 million performance bonus – while Grindrod earnings per share fell 63% (Vollgraaff, 2010, p. 3).
Another executive is reported to have received a R13.61 million bonus in the year his group’s headline earnings per share fell 77% (Vollgraaff, 2010, p. 3).
It is hardly surprising that one then finds headlines reading: “Performance formula as clear as mud” (Marais, 2010, p. 3).
“Among South Africa’s top 100 earners, there are only 13 who did not get a performance bonus last year. Yet 39 of the 100 companies they managed reported lower earnings” (Sunday Times Editorial, September 4, 2011).
“Lonmin’s directors were also patted on the back with six-digit performance bonuses despite a fall of 145% in the company’s headline earning” (Vollgraaff, 2011).
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shareholders. It could be argued that executives might be tempted to inflate performance results in order to ensure a commensurate increase in remuneration. Kidder and Buchholtz (2002, p. 601) suggest that adopting a principal-agent perspective may lead to self-serving behaviours, a view similar to that of Rodgers and Gago (2003, p. 189), who established that some executives with powerful incentives to enhance their remuneration had inflated their organisations’ financial results. Matsumara and Shin (2005) make a similar observation: that fraudulent behaviour may occur in order to increase remuneration. Perel (2003, p. 384) believes that a drive for better organisational performance should be accompanied by a concurrent focus on ethical behaviour, otherwise executives might act recklessly to maintain their remuneration and keep their jobs. Perel (2003, p. 387) further cites the example of Enron, where executives manipulated the organisation's earnings to raise the firm’s stock price and vastly increase the value of their stock options.
When adopting the simple approach of purely rewarding performance, the question can also be asked whether achievement is being encouraged at the cost of other stakeholders. King III advocates an inclusive approach to corporate governance, defining it as: "the board considering the legitimate interest and expectations of all stakeholders on the basis that this is in the best interest of the organisation, and not merely as an instrument to serve the interests of the shareholder" (IoD, 2009, p. 12). In view of this statement, basing remuneration purely on performance seems contrary to the inclusive approach. Perel (2003, p. 383) supports this view in that he believes that the focus on performance has caused executive remuneration to be firmly based on stock prices, which implies a focus solely on shareholder returns to the possible detriment of other stakeholders.
Another consideration when basing remuneration on performance is that if the principle of rewarding performance is reserved for certain classes of employees, to the exclusion of the rest of the workforce, it could be contrary to an inclusive governance
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approach. While executive remuneration might have a very clear link with performance, less senior members of the workforce are often remunerated annually on a negotiated, across-the- board increase with little or no link with performance. This scenario exemplifies the concern mentioned earlier, that although corporate governance advocates an inclusive approach, some practices might be considered contrary to this and inadvertently promote an approach based purely on the interests of shareholders.
One of the consequences of linking the remuneration package to organisational performance is that transparency might be compromised.
Vignette B: Lack of Transparency
Vignette B illustrates that using organisational performance as a determinant of executive remuneration increases the temptation to not adhere to one of the core ethical values of governance, namely transparency. Lawler (1990, p. 20), however, believes that this can be counteracted by making the link between pay and performance clearer by making information about the remuneration system public.
2.4.3.2 Risk propensity.
Another aspect that could be considered in the determination of the remuneration package of the executive is that remuneration could be considered a function of the
“...CEO of Telkom, Pinky Moholi failed the transparency test by not revealing to curious shareholders just why it made secret payment of R66.5 million to six executives in the past two years” (Rose, 2011).
“The furore over the paying out of bonuses and large salaries is symptomatic of a broader management problem where companies are not transparent with staff about the true state of their financial affairs” (Business Report, March 2010).
Lack of transparency on the calculation of performance bonuses, the setting of targets for executives, and companies' remuneration policies remain causes for concern, says shareholder activist Theo Botha (Marais, 2010, p. 3).
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differential risk borne (Nichols & Subramaniam 2001, p. 345). Executives carry far greater risk and responsibility than anyone else in the organisation. The issue is how this risk is calculated to determine a commensurate remuneration package.
2.4.3.3 Supply and demand in the labour market.
Perel (2003, p. 386) believes that remuneration packages of executives should have a direct relationship with the value of the services and the amount a future employer is willing to pay. Executives, by virtue of their skills, are in short supply which, according to Nichols and Subramaniam (2001), makes large remuneration packages inevitable. The economic world is regulated by market supply and demand, and this principle is also at play in the remuneration packages of executives. However, how much of this determination is objectively done, and how much is due to corporate vanity in an attempt to have a good public relations moment when announcing new executive remuneration packages? Perel (2003, p. 383) is of the opinion that, even though this scarcity of capable executives drives up their price, their very performance is by no means guaranteed. This is a view that appears to be shared by Icely, who, according to an article by Bonorchis (2011), is reported to have said that “a sense of entitlement appears to exist”, and “South African companies seem to be holding on to the myth of the indispensible executive.” Kolb (2006, p. 480) quotes Wilhelm (1993) who concluded that “the corporate board must recognize that surveys are bogus and CEO mobility is really low.”
Vignette C: Supply and demand in the labour market
“Companies claim to believe in the free market system, where success is rewarded and failure punished – but some choose to ignore this when it comes to enriching their executive team” (Sunday Times Editorial, September 4, 2011).
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Vignette D: Money does not retain
Vignettes C and D illustrate that, although it could be argued that supply and demand could be used to determine executive remuneration packages, huge values by no means ensure the retention of executives. This is aligned to Pfeffer’s (2001, p. 144) thinking – he believes that one of the myths regarding remuneration is the assumption that people essentially work for money. He states that companies that ignore the fact that employees essentially work to have meaning in their lives are doing nothing more than bribing their employees. He further believes that these companies will ultimately pay the price in the form of a lack of loyalty and commitment (Pfeffer, 2001).
2.4.3.4 Market surveys.
Another factor that could be considered in the determination of executive remuneration packages is research conducted in the market on remuneration received by peers within the same industry. Paying executives high remuneration in relation to their peers is frequently a case of little more than corporate vanity (Perel 2003, p. 383). Matsumara and Shin (2005) have a similar opinion, stating that executive remuneration disclosure may turn executive remuneration into a “beauty contest,” leading to increased
Cosatu spokesperson Patrick Craven, in an article published by fin24.com and in reference to the publishing of the “Rich List,” refutes the argument that executives need to be rewarded with huge packages as a manner to retain, as 20 of the top 100 highest-paid executives in 2010 are no longer in their positions today (2011). “Companies and the big parastatals argue that they need to pay well to retain top skills. This claim, however, can be challenged, as 21 of the 100 top earners of corporate South Africa in 2010 are no longer in their jobs a year later. At parastatals, the turnover of top executives is even higher” (Sunday Times Editorial, September 4, 2011).
“Big pay cheques do not seem to mean loyalty to a company as Ballandino is not the only person on the list of 100 biggest earners who is now a former director” (Vollgraaff, 2011). “...making a mockery out of claims by many companies that they need to pay excessive salaries, and dish out huge share options, retain top skills” (Peacock, 2011).
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levels of remuneration as firms seek to ensure that their executives are among the highest paid. Kolb (2006, p. 131), however, has a slightly different view on this, in that he believes that there appears to be some indication that executive remuneration surveys conducted by independent remuneration consultants may be skewed upward because the companies that respond do not want to damage their future recruitment and retention efforts by being perceived as paying less competitive remuneration.
Vignette E: Market surveys are not an exact science
It appears that, although market surveys or comparisons with peers in the industry seem to be a scientific approach to determining executive remuneration, this system might have some flaws. In this regard, Darcy quotes Warren Buffett as having written to his executives that the five worst words in the business lexicon are "everybody else does it" (2010, p. 205).
2.4.3.5 Remuneration consultants.
Organisations often recognise that they might not be competent to establish executive remuneration packages and, as a result, engage the services of remuneration consultants. “Thus organisations seeking to legitimise top-team pay setting are likely to use consultants as a legitimising conduit” (Conyon, Peck & Sadler, 2011, p. 33). Conyon, Peck and Sadler quote Bebchuk and Fried (2003, p. 78), who claim that “consultants would be loath to
Seeger (2010, p.1), of PriceWaterhouseCooopers SA, notes that “companies must stop trying to be at the median of the corporate remuneration scale and rather pay relative to the market, based on their own circumstances. Not everyone can be at the median.”
Reported in the Sunday Times of 5 December 2010: “...huge severance payments, lavish perks and outsized payments for ho-hum performance often occur because compensation committees have become slaves to comparative data. The committee is told about new perks that other managers are receiving. When compensation committees follow this ‘logic,’ yesterday’s most egregious excess becomes today’s baseline” (Laing, p. 5).
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provide advice that hurts the CEO’s pocketbook, as it is hardly a way to enhance the consultant’s chances of being hired in the future by this organisation or any other organisation” (Conyon et al., 2011, p. 39). Conyon et al. found that, in approximately 60% of the cases examined, the remuneration consultant supplied other business services to the firm (2011, p. 46), which led them to conclude that “the compensation of CEOs in organisations where the consultant provides other business services was found to be significantly higher than where the consultant does not” (2011, p. 52). This finding implies that the determination of remuneration packages for executives, even when done by a third party, is neither an exact science nor an objective process.
However, all of the abovementioned determinants of executive remuneration should be taken into consideration when determining a course of action that would be in line with the remuneration strategy of the organisation. This is discussed in more detail below.
2.4.3.6 Remuneration strategy.
An organisational strategy informs organisations regarding which actions to take on a daily basis in order to achieve a competitive advantage. As explained by Kirkpatrick (2009, p. 10), “...the board is responsible for reviewing and guiding corporate strategy.” This business strategy, however, needs to be supported by the remuneration strategy (Bussin, 2003). As the business strategy determines the actions the organisation will take to gain competitive advantage, so will the remuneration strategy determine how the board and remuneration committee deal with the challenges and approaches raised in the previous sections. The remuneration approach should be formalised in the remuneration policy. Bussin (2003) found the top five drivers in order of strength with regard to remuneration policy to be: retention of key staff, financial results, strategic thrust, surveys/benchmarking, and internal advisers. What is of concern, however, is that, in the study conducted by Bussin
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(2003), it was found that, out of 24 factors driving change to remuneration policy, governance was ranked only 21st.
2.4.3.7 Socio-economic issues.
Socio-economic issues are another factor that needs to be taken into consideration when dealing with executive remuneration, especially in South Africa, which has been described as one of the most unequal societies in the world.
It is an undisputed fact that South Africa carries the legacy of apartheid, which is typified by an uneven distribution of wealth, not only amongst the different races, but also between the genders. Vollgraaff (2011) reports that “Women account for about 52% of the SA population and slightly more than 45% of the labour force, but even the richest women in SA still languish far behind their male counterparts when it comes to earnings and wealth” (Sep 4, 2011). Lawler (1990, p. 23) goes one step further, stating that;
The key from a reward system point of view is to develop a pay system that reinforces the development of the right skill mix. And the reward system needs to do this not just at the senior management level but at all levels in the organisation.
This statement, made more than twenty years ago, is even more relevant in the current South African context, where skills development has become imperative.
Vignette F: Lack of transformation
Comparing the remuneration of executives with that of the rest of the workforce in organisations gives rise to another concern ‒ that of differential remuneration within organisations. While Nichols and Subramaniam (2001) refer to the differential risk borne by these two categories of employees as a possible reason for the differential remuneration, Perel
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(2003) adds that it could also be due to the value-add of these executives or their availability within the labour market.
The issue surrounding executive remuneration is, however, not the fact that there is a differentiation between these two groups, but rather the magnitude of the disparity. Furthermore, this disparity does not remain consistent, but appears to be continuously increasing. This sentiment is echoed in the Executive directors’ remuneration – Practice and
trends report published by PriceWaterhouseCoopers (2009, p. 13), where it is stated that
there is growing concern regarding the pay gap, and that there is increasing pressure on organisations to disclose the pay gap prevalent within their ranks. Vollgraaff (2011, p. 3) notes that “... there is a widening chasm between low, minimum-wage and executive director remuneration.” If one were to consider the above-cited considerations offered by Perel (2003) and Nichols and Subramaniam (2001) as justification for the differentiation in remuneration, it implies that the differentiation should remain consistent over time. This, however, is not the case. The divergence in remuneration between the lowest-earning employee and the highest-paid employee in organisations appears to be an exponentially- widening gap, and is a growing concern in the current socio-economic landscape of South Africa. It was reported by iol that, in recent strikes, unions defended their demands by referring to the awards received by executives, which outstrip anything that the ordinary employee might receive (2011).
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Vignette G: Widening wage gap
The seven possible determinants of executive remuneration packages include the issue of fairness or equity. Evaluations of fairness or equity should involve comparisons with standards or criteria that determine what is fair or equitable (Nichols & Subramaniam 2001, p. 341). Perel (2003, p. 388) states that “executive remuneration should be determined in relation to some value or standard, rather than being an arbitrary decision made by often ill- informed board members.” Whether remuneration packages are 'too much' or 'too little' is a meaningless value judgment in the absence of an objective standard. What are these values or standards, and by whom should they be determined?
Executives do not determine their own remuneration packages, so the issue of executive remuneration cannot be discussed only from the point of view of the executive.
“South Africa’s Gini coefficient, a measure of income inequality, is 0.68, according to the Treasury, one of the highest in the world and higher than at the end of apartheid. A reading of zero means complete equality, while a reading of one means complete inequality” (iol, 2011).
In an article by the Mail&Guardian, the National Union of Mineworkers's spokesperson is recorded as having said that executives are "raking in on average, R16-million a year," while the average salary for a gold miner is R3 800 per month (Rawoot, 2011).
After the publication of the Sunday Times Rich List in 2011, the leading union in South Africa, Cosatu, viewed the list as a confirmation that the "world’s most unequal society was growing