Dave Wheeler for HBR The idea of incentivizing CEOs and senior executives seems reasonable to most people. Yet the large executive bonus is a relatively recent phenomenon. Executive pay grew more slowly than the average worker’s income during the 50s, 60s and part of the 70s. It was in the 1980s that the ratio of CEO to average-worker pay grew dramatically. It “exploded” in the 1990s. The astronomical rates of CEO fixed pay and bonuses that we are so familiar with today are only about 20 years old. Some researchers have argued that they’re a failed experiment. At the organizational level, they can decrease morale and fuel cynicism, especially if CEO pay climbs while average wages stall or grow more slowly, as they have in countries like the U.S., UK, and Australia. Growing inequality has contributed to the decline in several social phenomena, including mental health, and has been cited as a threat to democracy itself. Is it now time to redesign the experiment? If so, how? One approach can be seen playing out in Australia. On July 1, 2011, the Australian Government amended the Corporations Act introducing the “two-strikes” rule. It works like this: If 25% or more of shareholders vote “no” in approving a company’s remuneration report at two consecutive annual general meetings, then the second meeting will determine if all directors need to stand for re-election. If this occurs then all directors (except the managing director) must stand for re-election within 90 days. This has given shareholders muscle and has changed the corporate environment around CEO bonuses. Further, it has provided boards with a rationale to act and the courage to do so. And is it working? Yes, so far. The country has witnessed numerous first strikes with boards quickly backtracking to save their skin. Among the crowd are some of the nation’s largest companies – CSL, Woodside Petroleum, AGL Energy, Boral, and Goodman Group. The mere threat of a first strike has had boards treading carefully. It’s clear that boards are starting to get the message from the national government, shareholders, the public, and the media that excessive executive packages are unacceptable. More than that, smart businesses are stepping forward to proactively embrace the changing culture. One business which typifies the change is Wesfarmers. The company is Australia’s eighth largest by market capitalization and an opinion leader in business circles. Highly diversified across food retailing, hardware, office supplies, department stores and industrial products, its current CEO, Richard Goyder, is stepping down to be replaced by an internal appointee, Rob Scott. Scott will earn up to $4 million less than his predecessor agreeing to a $1 million cut to fixed pay and a $3 million cut to bonuses. This shift is clearly coming from societal pressure. As Wesfarmers chairman, Michael Chaney, told the Australian Financial Review (AFR) “We recognize changes in the market that have seen downward pressure on fixed pay levels for CEOs and reductions in overall reward opportunities…[We] believe that this package and those of other senior executives in the Group are appropriate and in line with contemporary market practice of peers.” And the pressure continues. The current Australian Government, importantly from a different party to that which introduced the “two strikes” legislation, has gone in hard on Australia’s “big four” banks. In its May 2017 Budget, the government proposed a bank tax, like that in the U.K., and has clamped down on CEO pay. The banks, which enjoy a government-guaranteed status and owe much to the government for their security and profitability, have come up short in responding to a variety of customer issues. With the full backing of the public, the government announced a clampdown on how bonuses are paid and greater scrutiny of bank executives. Even the Prime Minister, Malcolm Turnbull, has waded into the issue. He was quoted in the AFR calling it “almost a cult of excessive executive CEO remuneration.” It’s also important to note that the mood in Australia is not exactly “anti-wealth.” No one is arguing that CEOs and entrepreneurs don’t deserve to be highly paid – provided they pay their fair share of taxes. These individuals have often taken huge risks, and very few succeed. Moreover, their wealth is often derived from the ownership of shares in the enterprise they founded. If someone wants to literally bet their house on the success of their business and ends up a billionaire, then most Australians would say good luck to them. The public’s concern is with professional managers who have risked little, but who think they have a right to earn Bill Gates money. That sentiment seems to be rising in other countries, too. Regulators and policy-makers in those countries can look to the Australian model for one example of how CEO pay might be reined in without heavy-handed regulation, and smart boards can get out ahead of the curve to satisfy shareholders, improve internal morale, and win the trust of the public.
On November 9, 2016, the shareholders of Australia’s largest company, and the world’s tenth-largest bank, revolted. The Commonwealth Bank’s shareholders were reacting to the board’s annual Remuneration Report, which contained a recommendation that the CEO be granted a bonus based on what critics saw as “soft” measures. Other firms have ventured down this path, including the conglomerate Wesfarmers, with its 200,000-plus staff, and the global hospital operator Ramsay Health Care. Should CEO performance be assessed only on “hard” measures? Should soft measures be part of a CEO’s scorecard? Is there a framework that might assist you to tackle the CEO appraisal task? CEO incentives have traditionally been evaluated against objective data — also labelled “hard.” Take, as an example, the world’s largest mining company by market capitalization, BHP Billiton. Its Remuneration Committee employs several key performance indicators (KPIs) to guide the compensation of senior executives. According to its annual report, those include financial metrics such as “attributable profit; underlying EBIT (earnings before interest and taxation); and total shareholder return (share price and dividends which are assumed to be reinvested).” What has emerged more recently is the use of nonfinancial, but still objective, KPIs. In BHP’s case, these are total recorded injury frequency and greenhouse gas emissions. Corporations are now taking a further step beyond objective metrics, which can be financial and nonfinancial, to include subjective measures — tagged as “soft.” In 2012 the Commonwealth Bank restructured its evaluation system so that 75% of CEO incentives came from the bank’s total shareholder return (TSR), relative to a set peer group, and 25% from customer-satisfaction results, benchmarked against another peer group. When this award structure reached the end of its four-year performance period, on June 30, 2016, in response to the ethical scandals within the bank’s life insurance arm, the bank’s board took yet another step to include even more subjective measures. Specifically, to help modify the bank’s culture to match its stated values, the Remuneration Committee and Board recommended a change to the reward split: TSR 50%, customer satisfaction 25%, and people and community 25%. The latter was concerned with “measuring long-term progress in the areas of diversity and inclusion, sustainability, and culture.” Now a full 50% of the assessment was subjective. This proved to be a step too far for some shareholders, precipitating their revolt in November 2016. Boards around the world find themselves in a bind. For the last 20 years they’ve gone down a path forged largely by U.S. corporations and global remuneration consultants. They now find themselves dissatisfied with the result, recognizing that they can’t simply rely on financial measures in assessing corporate performance and in distributing rewards to CEOs and senior executives. But they don’t really know what to do instead. As a consequence, companies are firing off ad hoc responses rather than approaching performance measurement in a comprehensive way. The Commonwealth Bank appeared to shareholders as simply putting out a fire. “Well-intentioned but not well designed” was how Ian Silk, the CEO of Australia’s biggest industry superannuation fund, AustralianSuper, assessed the bank’s attempt. The future of corporate reporting lies in an integrated approach. Here’s the framework I employ with boards and CEOs. I recommend using it in developing a corporate performance scorecard. It produces both objective and subjective measures: Recognize, as company law dictates, that a board’s primary responsibility is to look after the best interests of the company — not only those of shareholders. Develop a corporate scorecard focused on the relationships that the company has with its stakeholders, including customers, employees, shareholders, and suppliers. Acknowledge that the relationship between company and stakeholder is a two-way street. Develop measures on both sides recognizing that measuring performance is measuring relationships and that shareholder returns are driven by effective relationships with other stakeholders. Appreciate that those much-sought-after leading indicators are often those soft, subjective measures. Implement a short list of KPIs recognizing the cause-and-effect relationship between soft and hard measures. A recent study by AMP Capital observed that “incentives linked solely to financial metrics risk fuelling negative culture and conduct.” As a result, it noted: “Companies are increasingly focussing on setting non-financial targets alongside financial targets.” The Commonwealth Bank is one among many firms around the globe that is forging new ground. You might expect that the board, under its new chair’s leadership and following the kerfuffle, would back away from the issue. It has no intention of doing so. Instead, indications are that it will provide shareholders with additional context and logic on the thorny issue of soft measures as part of CEO assessment. That points to an additional step that firms can take: proactively preparing their shareholders to accept a different way of doing business.
Just days after troubled retailer Sears Holdings was put on (yet another) deathwatch after its stock crashed to all time lows while it CDS hit a record high, earlier this week, the short squeeze is back, with the stock surging 20% pre market, after the company announced it is planning steps to improve liquidity and financial flexibility, launching a strategic restructuring program intended to streamline operations and improve its dreadful operating performance, targeting cost cuts of at least $1 billion while repaying over a billion in outstanding pension obligations. The announcement comes as Sears announced another brutal quarter, in which revenue crashed 16% to $6.1 billion and net losses rose to $635 million from $580 million in the period last year according to preliminary results. For the full year, Sears expects revenues to fall 12% from last year to $22.1 billion. The company, controlled by its billionaire chief executive, Edward Lampert who over a decade ago took Kmart out of bankruptcy, announced his new plan to cut costs by at least $1 billion in 2017 by reducing overhead, improving merchandise at its stores and through better inventory management. Company CEO and Chairman said "to build on our positive momentum, today we are initiating a fundamental restructuring of our operations that targets at least $1.0 billion in cost savings on annualized basis, as well as improves our operating performance. To capture these savings, we plan to reduce our corporate overhead, more closely integrate our Sears and Kmart operations and improve our merchandising, supply chain and inventory management. While it reported a 10.3% plunge in comp sales, of which domestics same store sales tumbled 12.3%, and Kmart dropped 8%, Sears said it would cut debt and pension obligations by at least $1.5 billion this year. Sears also said it sold five Sears Full-line stores and two Sears Auto Centers for $72.5 million in January and engaged Eastdil Secured to raise at least $1 billion from the sale of its real estate. The company has also initiated the 150 store closures it previously announced, with the expectation that they will be completed during the first quarter. And the company has partnered with Eastdil Secured to sell at least $1 billion in real estate properties The retailer said that it would use the proceeds from last month's sales of its lawn and garden equipment brand, Craftsman, to Stanley Black & Decker, to reduce its debt and pension obligations by $1.5 billion for fiscal 2017. And so begins the latest in a series of many turnaround efforts, all of which have previously failed to spark a rebound in the melting ice cube. While it remains to be seen if this time will be different, for now the shorts, of which there are many, are scrambling to cover on what may be Sears' last hail mary.