To many people, the biggest issue with regard to CEO’s and Board’s of listed companies acting outside of shareholder interest is ‘Executive Remuneration’. I admit I have never been a particularly strident critic in this area. By this I mean that though I do think CEO pay packets tend to be higher than justifiable, I respect the market mechanism that makes the decisions and I am mindful that on a global scale Australian CEO’s are generally in the lower percentile bands for remuneration (for companies of comparable market cap). If shareholders become agitated enough, there is change. There are many flaws in this area, but I don’t agree it is as out of control as people (mostly the popular press) think. If there is one aspect of executive pay that does make my blood boil, that is the re-pricing of options. If a CEO makes an agreement about their pay, there should be no prospect of re-pricing the terms of that agreement at a later date, if conditions turn out to be more challenging than was thought at the time of negotiation.
For Australian listed companies, my number one bone of contention is capital management. In a well-run and profitable established business, substantial cash flows will be produced and the decision as to what to do with these funds (in combination with strategy) is probably the CEO and board’s greatest responsibility. Invariably, CEO’s will default toward the prospect of mergers and acquisitions (M&A), and it is in this area the greatest folly usually occurs. Integrating two businesses, if done well can substantially enhance results, for even when a full price is paid for a business, there are usually substantial savings to be garnered through eliminating duplicated functions. However, there is substantial evidence that the majority of M&A fail to generate anywhere near the expected benefits.
The reason CEO’s still default to M & A, despite the difficulties is often ‘empire building’. Empire building is a human instinct and is usually very powerful among the type of individuals who run corporations. It is not only the empire building instinct, but a dose of self-interest, caused by the fact that a CEO who runs a $500m corporation that earns $2 per share in profits will inevitably have a larger pay packet if he grows his company to a $2b company, even if it still only earns $2 per share. This is where the board must do its job and ensure the incentivisation of executives enhances earnings per share, but pays minimal interest in growth for growths sake.
One outstanding recent example of a clever capital management strategy, which caused me to choose this blog topic is the “Bonus Share Plan” – BSP announcement described here in the announcement by CWP (Cedar Woods Properties). I should disclose here that my wife owns shares in CWP. Disregarding my opinion that they represent very good value (even though their share price has nearly doubled in the last 6 months), the reason I like this announcement is because of the flexibility it gives shareholders in how they receive their funds from the business. You can either use the BSP to add new shares to your original cost base, which is what you would do if you were in an Income Tax bracket that was higher than the corporate tax rate. Alternatively you can take the dividends or use the Dividend Reinvestment Plan, in which case you would receive the franking credits, which you would obviously do if your shares were in a super fund, or you were in a tax bracket below the corporate rate. It would require considerably more explanation here just why this sort of option is a massive boon for shareholders, but suffice it to say this sort of shareholder-oriented action periodically strengthens my faith in corporate Australia.
The thing I found singularly most upsetting at the lows of the financial crisis was the dearth of share buy-backs and opportunistic acquisitions by those companies that had been foresightful enough to retain cash (rather than having every penny of leverage their permissive lenders would allow). Boards and CEO’s seem to have a perverse need to have their decisions justified by a buoyant market, when of course the best results would be achieved when moods are more subdued. – Tony Hansen 07/02/11
