The overpaid executive

Ruth Laugesen looks at the reasons for soaring executive salaries, and how they feed inequality.

Des Hunt has always called himself a capitalist. He was a major shareholder in rural supplies company Tru-Test, and made himself a fortune over 25 years. But these days, as corporate liaison for the Shareholders’ Association, Hunt is ashamed of what he sees as the greed of chief executives and directors in awarding themselves lavish pay rises, while those at the bottom face job insecurity and stagnant pay.

“I’m a capitalist but I’m so disgusted. I’m a member of the Institute of Directors, but I’m so embarrassed. The people at the bottom are struggling, and people at the top are getting too much. Capitalism can only survive if everybody is sharing some of the benefits,” says Hunt.

A decade ago, New Zealanders were agog that Telecom chief executive Theresa Gattung earned a total of $1.6 million in a year, more than 45 times the average annual income at that time. By last year, departing Telecom chief executive Paul Reynolds was earning $5.2 million, more than 100 times the average full-time worker’s $51,000 earnings. In just one week, Reynolds pulled in nearly twice what the average worker earns in a year.

At the New Zealand arm of Westpac, its chief executive earned $1.5 million at the turn of the century. Back then it was 34 times the average pay of Westpac front-line bank workers. By last year, New Zealand CEO George Frazis was earning $5.4 million, more than 90 times the average pay of one of his staff. (The average bank worker’s pay, as provided by the finance sector’s First Union, is based on a mid-range sales role, and includes a loading for superannuation, bonuses and other employment benefits.)

It isn’t just a few corporate superstars who are cashing in. The rising tide of corporate pay has helped float executive boats elsewhere in the economy, contributing to a furious backlash in Christchurch, where 4000 people marched recently to protest against the $68,000 pay rise awarded to city council chief executive Tony Marryatt. Professional firefighter Kelvin Hampton noted during the Christchurch rally that Marryatt’s rise was more than he made in an entire year. (Marryatt turned down the rise because of public pressure.)

Packages such as the $540,000 originally offered to Marryatt have sprung out of a culture that has elevated leadership as being the critical ingredient in the success or failure of an enterprise. But many ordinary workers find it difficult to comprehend how that worth is actually calculated, and have a sneaking suspicion that the link between effort and reward has become, at best, tenuous. Local fury over excessive pay for those at the top has not yet reached the levels seen overseas, but it’s all part of a global backlash against what many see as an unfair distribution of wealth.

Even our cash-strapped universities appear happy to play the game. At the University of Auckland, Vice-Chancellor Stuart McCutcheon was paid $640,000 last year – up 75% on the $360,000 John Hood was reported to have received 10 years earlier. Meanwhile, Auckland’s teaching staff – who are also vital to the competitiveness and quality of any university – received an average pay increase of 47% over the same period.

“Are today’s vice-chancellors twice as useful or talented or whatever as their predecessors two decades ago?” asks University of Auckland economics professor Tim Hazledine. He thinks not. He also notes that as pay at the very top goes up, it tends to rise for other senior managers. Hazledine has calculated that the total salary bill for senior managers of the country’s 30 tertiary institutions is now nearly seven times what it was a decade ago – $68 million, up from $10 million. “These are starting to look like serious numbers, with implications not just for income distribution but also for how universities actually function. The gut feeling of most of us shop-floor academics is that this bloated superstructure of managers has not increased our productivity.”

The core public sector is rife with similar grumbles from those at the coalface – or perhaps chalkface. Although pay rises for public-sector chief executives have slowed sharply – with a median rise of only 2% last year for heads of government departments, district health boards and tertiary institutions – their absolute levels of pay are still at historically high levels.

For example, secondary school teachers were the beneficiaries of a much-heralded pay catch-up in the 2000s, which saw their average pay rise 45% to $71,000. This increase was considered worthy of a separate page on the Ministry of Education’s website, which made favourable comparisons with other sectors. But there is no corresponding web page on the soaring salary of the Ministry of Education head, which rose 65% between 2000 and 2010, to over $520,000.

Pay rates in the private sector have ballooned not just in the largest corporates, such as the telcos and banks. According to remuneration consultants Strategic Pay, for private-sector organisations with a turnover of around $350 million a year and over 1000 employees, senior executive pay has risen 84% in the decade to 2011, to a median of $670,000. And for private companies with a turn­over of around $100 million, total remuneration has risen 60% to about $500,000.

Keeping tabs on pay levels may be more an art than a science, however, as another consultancy, Moyle Remuneration, has drawn dramatically different conclusions. Its figures suggest pay for chief executives has been rising more slowly than for the average worker. According to its records, for organisations with a turnover of $100-200 million, median CEO remuneration was up only 40% in the decade to 2010, to $385,000. For organisations with a turn­over of $200-500 million, remuneration was up 23% to $450,000, and for those with turnover above $500 million, it was up only 12% to $675,000 over the decade.

Are CEOs really worth their big pay packets? Or are these super-salaries, as Guardian columnist George Monbiot put it, “a form of institutionalised theft, arranged by a kleptocratic class for the benefit of its members”? Business Roundtable chairman Roger Partridge says New Zealander Sir Ralph Norris was worth every cent of the A$16 million he was paid in 2010 (more than NZ$21 million at that time) as head of the Commonwealth Bank of Australia. In the time he headed the bank, its market capitalisation increased by A$30 billion, and it rose from the fifth to the second biggest company by market capitalisation on the Australian Stock Exchange, says Partridge.

Norris’s pay, he argues, was just a fraction of the value he returned to shareholders. “When it came to shareholders voting on his pay, it was approved by 96% of them, and you can see why. He brought a star quality to the role and added value.” However, the monster pay packet ended up biting Norris in the rear. Soon after the remuneration was revealed, the bank raised its mortgage interest rates even though the official cash rate had just been cut; bank customers took to the streets and burnt effigies of Norris. He was forced to take a $7 million pay cut the next year when customer-satisfaction ratings plunged.

Highly paid CEOs can certainly be worth it, says Joan Withers, chairwoman of Auckland International Airport and Mighty River Power. Some of them, she says, “walk on water”, defying market conditions in their sector to deliver solid performance or increase the company’s market share. She believes those chief executives are worth a good 20% more than the market median.

“There are some companies where the staff actually think they’ve got an inspirational leader. They believe that leader is ensuring their own futures, because that leader knows what they’re doing and they’re running their business successfully.” She says boards have become acutely aware of rising public concern about executive pay, and of the darkening global mood on corporatism. “What I’m seeing on the boards I’m on is that this issue is exercising the minds of directors. They’re spending a lot of time working through the minefield that is executive remuneration at the moment. The challenge for all of us who are directors is to ensure in setting those remuneration structures we’re able to attract and retain talent in those very senior positions.”

Withers says CEO pay rates are a reflection of high market demand for a scarce skill. The market for top CEOs is a global one, and one local companies can’t ignore. However, New Zealand organisations can get away with paying a shade less because of the drawcard of the New Zealand lifestyle and environment. Does she sympathise with the firefighter whose entire pay is lower than Marryatt’s rise? “We can all relate to that,” says Withers. “When we see pay packets coming out for expat New Zealanders, when they get A$16 million, we sort of draw a breath. But if that’s the market, I guess that’s the market,” she says.

In the banking sector there have been some “egregious examples of excess”, she concedes, “but ultimately there is a differential. It’s about supply and demand; it’s about the amount of qualifications and training you need to fulfil these roles, and the need for ongoing development. If you could find a thousand people of the appropriate calibre to go into the role, and they were all prepared to accept a much lower level salary, then that’s what would happen.”

Christchurch City Council’s Marryatt has said all he wants is the fair market rate, whether it be $200,000 or $1 million. “All I’ve ever said to my council is, ‘You tell me what the market is, and I’m happy to be on that range, whatever it is,’” he told TV3.

The oracles in divining market rates of pay are the remuneration consultants, firms that survey hundreds or thousands of organisations nationwide and build up valuable, closely guarded databases. One such firm is Strategic Pay, which the Christchurch City Council turned to for advice. Several factors created a perfect storm of pay inflation for Marry­att. First, the council asked Strategic Pay to benchmark against an average of both public-sector and private-sector pay, making for a higher rate because of higher private-sector pay levels. Second, Strategic Pay suggested paying the median market rate or more, saying in its advice it was normal practice to progress towards the median “or beyond” for fully competent performance. Third, Marryatt’s pay was already high, meaning even a small percentage increase would look big to the average worker.

Strategic Pay advised that the market median for Marryatt’s type of job had risen by 5.1% to $494,517 and that he should be paid at that level or up to 3% higher, even for “satisfactory” performance. Mayor Bob Parker, head of the remuneration committee, went one better, recommending to the full council that Marryatt be paid 9% above the median, which meant a total 14% rise.

Marryatt was a beneficiary of what is known as the “Lake Wobegon effect”, named after a fictional town on radio show The Prairie Home Companion. In Lake Wobe­gon, “all the women are strong, all the men are good looking and all the children are above average”. In this vein, there are strong pressures for a board or council to see its chief executive as average or above. To think otherwise suggests either they are satisfied with a substandard CEO, or they might need to look for a new one.

At the Kapiti District Council, Mayor Jenny Rowan justified the council’s recent $44,000 pay rise for chief executive Pat Dougherty not on the grounds of competence or performance, but because he was being paid “substantially less than the market rate”. Yet Dougherty’s tenure included substantial cost overruns on multi­million-dollar council projects.

You don’t need to be a mathematician to work out that if pay consistently trends to the median or above, the median itself will continue to rise. Asked to comment on the validity of the Lake Wobegon effect, Strategic Pay managing director John McGill says, “It’s not bad.” But there is an enormous range of pay levels in any market, he says, and CEO pay is no exception. Some organisations have a policy of paying around the median, he says, others in the lower quartile and others in the upper quartile.

Could conflicts of interest also be feeding the executive pay spiral? In the US, new rules were introduced in 2010 requiring companies to disclose the fees they pay to remuneration consultants if the consultants are also hired for other work. The concern was that if a consultant was advising on chief executive pay, while also getting work from the chief executive to provide other advice, that this would create incentives to back hefty pay rises for the boss to assure a continuing flow of work.

Strategic Pay has confirmed to the Listener that it had a potential conflict of interest in Christchurch. It was advising the mayor and councillors on the CEO’s pay levels, while also carrying out work for the CEO. “Christchurch City Council have been clients of ours for a long time. We would work generally quite closely with the chief executive when it comes to looking at their direct reports,” says McGill.

Does that not create a potential conflict of interest? “Yes, a potential conflict of interest is always there, yes, but we believe in – subject to the usual rules of confidentiality and commercial sensitivity – being sensitive to the fact there is a potential conflict of interest and we want to appear squeaky clean.” How does Strategic Pay ensure it is squeaky clean? “By being transparent in what we do. If stuff gets published as we’ve seen in the last week, which is pretty unusual, people can see what we’ve said. The issue does get raised and we make sure there’s no conflict in terms of what we do, insofar as we can. There aren’t very many organisations who specialise in this work in New Zealand.”

Christchurch City Council declined to give the Listener any details of how much work Strategic Pay had done for the council’s executive team over time, or the value of that work, by press time. It said the request would be dealt with under the Official Information Act, which would take 20 working days.

Apart from the march in Christ­church and a protest at the Kapiti District Council, the mood in New Zealand on corporate pay has been relatively muted so far, reflecting smaller extremes in pay packages than those found in Australia, the US and the UK. In those countries, a mood of revulsion against what is seen as greed at the top is sweeping through the political establishment. In the US, where inequalities are particularly extreme, the Occupy movement has flipped the political discourse by drawing attention to the amount of wealth and power cornered by the top 1% of earners. Now it is respectable, even in the Republican Party, to call the rich to account. Republican presidential candidate Newt Gingrich’s main attack lines on Mitt Romney have been how little tax Romney pays, and Romney’s corporate record of closing small-town family businesses.

In the UK, Prime Minister David Cameron began the new year with policies to restrain corporate pay, saying it was time to reconnect “the principles of risk, hard work and success with reward”. Proposals include giving shareholders a direct vote on corporate pay packages, and compelling large companies to introduce a clawback mechanism to retrieve bonuses if a company fails.

Former Royal Bank of Scotland boss Fred Goodwin has been stripped of his knighthood for bringing the honours system “into disrepute”. Goodwin kept a $30.5 million pension package despite the British Government having to bail out the firm to the tune of $85.5 billion. In Europe, the head of the organisation that represents the world’s banks, Deutsche Bank CEO Josef Ackermann, recently warned of a “social time bomb” from wealth and income equality.

In Australia, the Gillard Government introduced legislation last July that gave shareholders a voice on pay. Under the “two strikes” rule, if 25% or more of votes at two consecutive annual meetings oppose a company’s remuneration report, shareholders can then vote to require the directors to face a re-election. By late last year at least 13 large companies had recorded their first “strike” under the new regime.

Here, there is no government mood for action on corporate pay. “We don’t believe there’s a significant problem and I think companies will be picking up the shift in public views about what people get paid right at the top end,” says Finance Minister Bill English. He says the bigger challenge for New Zealand is the bottom end. “And getting people on the ladder of opportunity.” In the public sector, he says, National has told bosses their rises should be in line with general pay movements in the sector. For government departments, universities, polytechs and health boards, the median chief executive pay rose 2% in 2011.

Withers says she supports more transparency in how boards report on remuneration, saying it’s time for directors to have a rethink on the whole issue. “We need a comprehensive piece of work to look at remuneration, at transparency, and how it should be reported and what’s best practice. The big issue is getting small shareholders and staff who work at these organisations to understand better what is involved in setting remuneration for the chief executive.” She thinks if boards show more clearly how pay is linked to performance, that would increase support for the packages. Auckland International Airport discloses not just its chief executive’s total remuneration, but how that is broken down into base pay and incentive pay.

“The biggest underlying problem for all of us at the moment is we’ve got an environment in which the reputation of the corporate cohort is really suffering from what has been a tsunami of bad news and stories of really egregious behaviour, especially some of the stuff coming out of the UK. People think they’re all rich fat cats doing nothing and getting all this pay, and that’s the problem.”

The Shareholders’ Association’s Hunt says those at the top should not be getting cost-of-living increases that those further down might get, because pay at the top is already “ripping ahead”. “If a company performs well, like Mainfreight or Ryman, I’m not against those people earning a nice bonus, subject to it having relevance to shareholders’ return and also other employees in the company getting some of the benefits.” He thinks employers need to show greater fairness to all their workers before the extent of inequality brings capitalism itself into question.

“Remember when the unions were too powerful. Now the pendulum has swung too far the other way. We don’t want to get to the stage where it becomes about the capitalism system not working.”

UP, UP & AWAY

Average salaries vs those at the top

• 2001 Telecom CEO Theresa Gattung: $1.6 million
• More than 45 times the average full-time earnings of $35,000
• 2011 Telecom CEO Paul Reynolds: $5.2 million
• More than 100 times average full-time earnings of $51,000
• 2000 Westpac NZ CEO Harry Price: $1.4 million
• 34 times the pay of an average Westpac front-line bank worker
• 2010 Westpac NZ CEO George Frazis: $5.4 million
• 90 times the pay of an average Westpac front-line bank worker

More unequal than others

Those at the top have pulled further ahead in the past two decades, so what’s the Government’s plan for tackling poverty and inequality?

Unusually, Finance Minister Bill English isn’t sure what he thinks. The -Listener has asked if New Zealand is too unequal. “You don’t get that choice, actually. You don’t get the choice of saying I’d like less inequality. You don’t have the levers.” Surely he must have an opinion whether, in an ideal world, this society is too unequal. “I don’t know the answer to that. There is inequality. Part of that is what you get in a society where there’s equal opportunity. You get different results.”

English is the head of a new ministerial committee on poverty, the result of the Maori Party’s support agreement with National. The committee is interested in two things, says English: increasing economic mobility and ensuring the Government is getting value for money in the billions of dollars it spends on social intervention. By economic mobility he means “people being able to move out of the trap of long-term low incomes”, a trap that too often is inter-generational. In New Zealand inequality hasn’t increased since National came into office in 2008 – in fact, 2010 figures show it has diminished slightly, probably because top earners suffered investment losses during the global financial crisis. However, the long-term picture over the past 20 years is that the biggest income gains have gone to the top 10% of income earners, while incomes for the bottom half of earners have dropped or become stagnant.

What National won’t be doing, says English, is putting any more money into lifting the incomes of entire groups, as Labour did with Working for Families. And he certainly doesn’t think restoring some strength to trade unions is a way to improve the wages of those at the bottom. ”We don’t agree generally with the theories that you can construct equality. The fact is the global influences on our workforce are very significant and you can’t influence them that much. Jobs come, jobs go. The idea you can stand there and push the sea back is just a bit romantic. You’ve got to boil it down to the levers that are movable. A government can’t have a lot of impact on the job market. It is what it is.”

Where government can make a difference, he says, is in educational achievement, housing and incentives to work, all crucial for economic mobility. English has been reading The Race Between Education and Technology, by Harvard economists Claudia Goldin and Lawrence Katz, which argues that failures in America’s education system were largely to blame for that country’s accelerating inequality gap from the 1970s.

“We know that the returns to skills are rising, and we have a wider distribution of skill because we have failed to educate sufficiently about 15% of the population. And it happens that that part of the population looks like part of the inequality problem.” There’s a “reasonable evidence base” that if you get level 2 NCEA, your chances of getting better paid work, or work at all, are higher, he says. “That’s really become the entry level qualification for the workforce. The number of kids getting it has risen, but it’s got a long way to go, particularly among Maori and Pacific boys, and that’s one factor for mobility.”

He points to the Government’s youth guarantee scheme as a policy that will help kids who don’t do well at school. The scheme gives free enrolment on specific level 1-3 courses at polytechs for 16- and 17-year-olds. Last year there were 2500 places; this year the number will triple to 7500. On the employment front, he says National’s welfare reforms will increase incentives for beneficiaries to return to work. More than 300,000 working-age people are on benefits, and during the election National claimed it could cut that by 46,000. Unemployment and sickness beneficiaries are to go on a new “jobseeker support” benefit, with work expectations according to capability. Single parents on a benefit will be expected to be available for part-time work when their youngest child turns five, and available for full-time work when their youngest turns 14.

With housing, major changes are in the wind. Officials have labelled the current situation as “unsustainable” in their advice to the incoming government. Currently, about 20-25% of households get some sort of housing help from the state, either an accommodation supplement or state housing. State housing is “trapping thousands of people”, says English. How so? “If you are on a benefit and in a Housing Corp house, it’s almost impossible to propel yourself out of there. Because you need to find a pretty well-paid job to make you better off than staying where you are. So it’s nothing to do with people being lazy – it’s just the incentive on them to stay dependent.”
There is a role for state housing, he says, but it is “not to trap people in long-term low incomes; it’s to assist them when they need it and help them back into a self-sustaining life”.

English says the Government will still provide some state housing, as well as help through the accommodation supplement. In December 2010 the Government agreed to encourage more outside social agencies, such as the Salvation Army and Maori organisations, to provide housing. They are to be helped by capital grants or by the transfer of state houses. The new Social Housing Unit has a budget of $37 million to fund new or emerging housing providers. Change has been under way for a year, “but the steps are going to get bigger”.
English says the Government is also planning big changes in the way it co-ordinates services across departments, including amending the State Sector Act and the Public Finance Act to allow several departments to share responsibility for particular outcomes. “I think generally New Zealanders like to think of us as having an egalitarian society. They don’t want too much inequality and they’ve got a strong sense of fairness.”