A research team from Monash Business School has found a direct link between the way finance sector CEOs are paid and the chance their companies will be investigated or penalised by the corporate watchdog.
In one of the first studies to find such a direct link, researchers concluded adverse firm events were 42 percent more likely to occur when the majority of CEO pay consisted of stock options and shares.
Using a sample of 23 CEOs from 12 of Australia's largest financial institutions, the study identified 75 adverse events in the two-year period after these executives departed from their roles.
John Mitchelhill, lead author and Honours student at the Monash Business School's Department of Management, explains not all types of variable CEO pay have the same effect however, with the most negative and significant relationship found with short-term variable pay.
"I contend that existing pay practices fail to align interests between the CEO and shareholders, therefore failing to mitigate CEO risk propensity and the likelihood of negative behaviour," he says.
"In turn, I suggest that variable CEO pay is in fact increasing, rather than decreasing the likelihood for adverse firm events to occur."
The study is released as leaders of Australia's largest financial institutions continue to face criticism from stakeholders for their lucrative pay packets, driven primarily by risk-based incentives and bonuses.
The mean annual total remuneration package for the CEOs in the study was $8 million - nearly double the mean CEO pay in other ASX100 companies.
Mitchelhill suggests boards of directors should look at enforcing minimum shareholding requirements as it would temper CEO risk, knowing there is a greater level of wealth at stake.
He says this could potentially reduce the number of adverse events that occur during and after CEOs leave a company.
"While no adverse events occurred for the majority of CEOs in the study, however, when one event occurred, it was likely that other 'negative' events followed," Mitchelhill says.
The research used former Commonwealth Bank (ASX: CBA) Ian Narev as an example, having received total statutory remuneration of $5.5 million in FY17, much of which was attributed to cash bonuses, stock options and share incentives.
In the two-year period following Narev's departure amid fraud and money-laundering concerns, CBA, amongst other things, were:
- Forced to repay $119 million (including interest) for fees for no service.
- Required to pay $15 million for rigging the Bank Bill Swap Rate (BBSW).
- Made to refund $10 million after selling more than 65,000 customers unsuitable insurances.
Mitchelhill's research, which was supervised by Professor Mathew Hayward and Associate Professor Pitosh Heyden, also found that incentive pay was up to 90 per cent higher than the amount received as a fixed salary for some CEOs.
"The research challenges Boards of Directors of Australia's largest financial institutions to drop their 'mutual back scratching' and place greater weighting on non-financial performance metrics," he says.
A call for boards to take leadership with fresh approach
Boards of directors for ASX listed companies traditionally determine CEO pay through a remuneration committee, but Mitchellhill argues boards need to show more leadership in their decisions.
He calls for a focus on non-financial metrics such as corporate social responsibility (CSR), quality of service and governance, instead of just improving company financial performance.
"However, evidence suggests there is a link between highly paid boards of directors and highly paid CEOs. This can result in directors who may not want to bring attention to a firm culture of excessively paying executives due to the potential for their own excessive pay to also be critiqued," he says.
"In addition, boards are often stacked with friends of friends and directors who sit on multiple other ASX Boards, resulting in circumstances where it's not in a Director's best interests to criticise friends and colleagues due to a potential impact to their future job prospects."
Mitchelhill says the evidence captured in the research implies the effects of CEO actions are often not fully known until once they have left the company, and that these CEO actions are likely influenced by the type and amount of remuneration received by the CEO during their tenure.
"This finding aligns to literature from Aboody and Kaznik (1999), who found that CEOs engage in self-serving behaviour that maximises their own remuneration, such as through deliberately timing the release of voluntary disclosures or misreporting financial results," he says.
The lead author offers a range of possible mitigative solutions. In addition to more non-performance metrics and finding alternatives to total shareholder return (TSR) calculation, he elaborates on the rationale behind a minimum shareholding requirement.
"Doing so may mitigate moral hazard amongst CEOs through ensuring they have a greater level of perceived wealth at risk, therefore potentially reducing the number of adverse events which occur after the CEO leaves their company," he concludes, also arguing for an even split across each variable pay component.
"Doing so may be achieved through ensuring both short-term and long-term variable remuneration have the same maximum allocation of 150 per cent of the CEO's total fixed remuneration, which currently is not the case at some of Australia's largest retail banks."
The companies covered by the study were National Australia Bank (ASX: NAB), QBE Insurance Group (ASX: QBE), Insurance Australia Group (ASX: IAG), Medibank Private (ASX: MPL), ANZ (ASX: ANZ), Bendigo and Adelaide Bank (ASX: BEN), Suncorp Group (ASX: SUN), Westpac (ASX: WBC), Macquarie Group (ASX: MQG), Bank of Queensland (ASX: BOQ), AMP (ASX: AMP) and Commonwealth Bank (ASX: CBA).
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