Boards need to show some remuneration restraint or pay the price
Thursday February 10, 2011
Some corporate cultures treat the performance bonus as a right, writes Hannah Piterman. EXECUTIVE pay continues to be a lightning rod for shareholder complaint. A perceived disconnect between executive pay and company performance has seen a majority of shareholders vote down the remuneration reports of eight of 200 companies in 2010, equalling 2008's record for protest votes since the non-binding vote on pay was introduced in 2005.Proposed federal government reforms have introduced draft provisions to claw back bonuses paid where profits turn out to be materially misstated, an add-on to the government's response to the Productivity Commission's review into executive pay that recommends that, if 25 per cent or more of shareholders reject the remuneration report two years in a row, all shareholders should then vote on whether to hold a new election for board members at an extraordinary general meeting.Legislation that requires executives and directors to repay bonuses paid on the basis of materially misleading financial statements is a post hoc reconciliation that does little to tackle governance oversight and inadvertently may legitimise deviant corporate behaviour.While proposed legislative reform may force greater accountability and place limits on creative financial engineering, it cannot fix a corporate culture in which distorted notions of individual entitlement have favoured incentive structures that are skewed towards self-interest and the short term.Business groups in the main oppose the proposed legislation on the basis that external monitoring would not only be unduly interventionist and difficult to administer but that the oversight of executive remuneration is an internal governance issue. However, if business takes a stance on the legislation it also needs to show leadership by challenging those corporate cultures in which the performance bonus is treated as a right with little connection to the financial health of the organisation.Failure to align pay with real objective performance is an indictment of a board culture that is willing to turn a blind eye to matters both financial and moral. In his article Turning a Blind Eye: The Cover Up for Oedipus, British psychoanalyst John Steiner argues that the act of turning a blind eye is one of those perverse mechanisms in which the awful truth is acknowledged and disavowed at the same time.At one extreme we are dealing with simple fraud, in which an accounting sleight of hand is the reward for those clever enough to get away with it. More often, however, a situation of collusive denial becomes so ingrained into the board's modus operandi that any material evidence that may threaten the status quo is discarded before it can be readily assessed. This creates a collective board dynamic manifested in a point-blank refusal to draw inferences from negative signals, a failure to be open to challenge and a culture that punishes dissent.Recent history in the financial sector has exposed the lethal consequences of indefensible corporate irresponsibility rooted in complacency in accountability and the privileging of self-interest above moral, regulatory and material constraints. The recently released US Financial Crisis Commission's report lays the blame squarely on systemic incompetency and avarice as opposed to law-breaking. However, whether the grand errors of judgment made were due to ignorance or malfeasance is a moot point. At its core is a failure of leadership to provide a safe climate for good governance, one which enables board members to be fully engaged in bringing maturity, wisdom, experience, knowledge, and integrity to the task.It requires fortitude to deal with complex issues appropriately and eschew the pull of expediency, simplification and a cosy sense of comfort that spawns groupthink and complacency. High-performing boards embrace reflection, diversity and debate. Above all, its members are uncompromisingly independent in exercising judgment.Research suggests that gender-diverse boards are more likely to be high quality than are male-only boards. Women on boards are likely to be more active and independent. Women are more likely to question conventional wisdom and speak up when concerned or in doubt about an issue. Moreover, the presence of women on boards changes the culture of the boardroom, leading to different discussion patterns and increased debate.Research published in 2010 by Insync and Gender Worx on the effectiveness of boards in Australia and New Zealand based on the views of 849 directors who serve on 105 boards found that gender-diverse boards (at least 33 per cent women) show a greater propensity for pursuing good governance, had higher integrity and were more vigilant in questioning the connection between management pay and performance.In a climate of intensified public scrutiny business cannot afford the reputational damage associated with questionable or lax governance. Ensuring greater board independence through enhancing diversity of board composition is a step in the right direction.