Company performance and executive pay – the weakest link

Cavalier Corp chairwoman Sarah Haydon says there is not necessarily a correlation between a CEO "busting a gut" and company returns.

In 2009 researchers from the universities of Utah and Purdue looked at the relationship between the incentive pay of chief executives and the performance of their companies.

The finding?

“Firms that pay their CEOs in the top 10% of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers.”

A study published in 2016 by MSCI on the same topic found: “Companies that awarded their chief executive officers (CEOs) higher equity incentives had below-median returns based on a sample of 429 large-cap US companies observed from 2006 to 2015.

“On a 10-year cumulative basis, total shareholder returns of those companies whose total summary pay … was below their sector median outperformed those companies where pay exceeded the sector median by as much as 39%.”

A study of pay and performance in corporates from 1991 to 2002 by researchers at Stanford, Pennsylvania and New York universities found small firms with highly paid CEOs, particularly where the company had a large shareholder, tended to have good performance.

However, “In many large firms, the highest-paid executives actually performed the worst,” Stanford Professor Robert Daines concluded.

These are just some of the many studies into the relationship between executive pay and company performance and they reflect the general results – there just doesn’t seem to be much of a connection.

So what about New Zealand?

If we were to look at the five-year performance of our listed companies and compare it to how much their chief executives were paid, would we find the best paid produced the best performance?

In a nutshell – not really.

To look into the relationship between pay and performance in New Zealand, NBR took a sample of the 10 best and worst performing companies in the five years to June 30, ranked by total shareholder return, and correlated the results with the average annual pay of their chief executives as disclosed in their annual reports.

KPIs
After crunching the numbers the correlation came out at 0.2 – a positive relationship but not a strong one.

What does that mean?

“I think you’re opening up a can of worms,” Forsyth Barr head of research Andy Bowley says.


Forsyth Barr head of research Andy Bowley says looking for a connection between CEO pay and company performance is "opening up a can of worms."

“There are myriad different [key performance indicators] included in executive compensation. Some are more appropriate than others. I’m a believer that return on capital rather than various profit and loss measures is arguably more important,” he says.

“But there are many influences on corporate performance which have nothing to do with the chief executive.”

However, Mr Bowley adds, “You get great CEOs who at times are unable to add value.”

The best performing company over the period was Tourism Holdings, with a return of 1069% according to Bloomberg data. Its chief executive, Grant Webster, took on the role in December 2008 after several years in the company as a senior executive.

Mr Webster’s pay in the year to June topped $1 million, according to the company’s annual report but his relatively low pay at the start of the five-year period pulled his average annual pay down to $777,126, the second lowest in the top 10.

The highest pay went to Air New Zealand’s Christopher Luxon who received well over $4.5 million in each of the past two years, generating an average pay level for the Air NZ chief executive of $3.9 million. Air NZ was also one of the highest performers, producing a total shareholder return of 621% for the five years.

But some of the results outside those peaks are equally important. Nine of the top 10 companies had better performance than healthcare group Ebos, for example, but only two of them paid their CEOs more.

Four of the worst
Meanwhile, four of the worst performing companies – NZ Refining, The Warehouse Group, NZX and Sky TV – paid their CEOs at least twice as much as the best performer.

If shareholder return was the only goal, paying the CEO a lot doesn’t appear to be a good way to achieve it.

Something else must be going on.

For a start, how a chief executive is paid has a lot to do with the nature of the company and the identity of the CEO.

Shareholders Association chief executive Michael Midgley is quite clear that companies may need to pay well to get the person they want.

“You have to pay for quality and you have to reward people,” he says. “The criteria should always be the best person for the job and bigger companies may be more complex [to manage].”


Strategic Pay chief executive John McGill says more work required on incentive pay components.

However, “what you pay doesn’t always get you results,” he says, citing the poor performance of Fletcher Building, whose CEO Mark Adamson was one of the highest paid on the NZX.

The case highlights one of the difficulties for boards – how do they structure their CEO’s pay package to balance the right short and long-term incentives?

There is no magic formula for that, says Milford Asset Management portfolio manager Sam Trethewey.

“It depends on the situation the company’s in and the type of industry it’s in, and also the situation of the CEO – whether that person’s coming in to turn a company around or build it from where it is.

“It means it’s difficult to get a consistent approach to this but where the CEOs get paid a lower base fee and have more at risk based on the performance of the company is the ideal outcome.”

What a CEO’s performance targets should be will also vary. Financial measures are important but so are more qualitative goals, Mr Trethewey says.

“An example of that is Air New Zealand and the morale of staff. The employees there are proud to work for that company and it’s reflected in the way it performs. The chief executive is a big part of driving that.”

Worth their weight
Stephen Bennie, co-founder of fund manager Castle Point, has no problem with some CEOs being paid a lot of money.

“They can literally be worth their weight in gold because they create billions of dollars in value for the shareholder.”

However, “the interesting thing is the majority of CEOs are not worth what they’re paid. It’s just that they’re paid the same as the good CEOs.

“I’ve got to the stage where I just accept it. It is what it is. It’s a heck of a thing to try to sort.

As an investor, Mr Bennie says one of the factors Castle Point taps into is a CEO with a sense of ownership – out of 15 companies in its Ranger Fund eight have founders or shareholders as CEOs.

“You get this nice alignment occurring where you get someone who’s clearly had a long-term vision of creating value,” Mr Bennie says.

“These are people who have a long-term viewpoint. There’s no empire building. It’s about adding value to the business because that’s what they want to do. It’s their life’s work you could say.”

There are exceptions such as A2 Milk where managing director Geoff Babidge came in and created huge value, and Port of Tauranga, where chief executive Mark Cairns and chief financial officer Steve Gray have a long-term attitude, says Mr Bennie.

“They don’t have vast shareholdings in the business by any means but they treat it as an asset they’re looking after until the next generation.”

One of the things boards are trying to do is use short and long-term incentive pay structures to engender that kind of thinking but it’s not easy.

Tourism Holdings chairman Rob Campbell – who also serves on several other boards including as chairman of SkyCity – is not surprised by the limited correlation between CEOs’ pay and shareholders’ returns.

“I really don’t have any business in which I think we have the CEO remuneration level or structure optimal,” he says.

Issues that can affect that relationship include the economics of the business and its market, which is typically greater than anything a CEO can do, while incentive structures are “quite clumsy in terms of inducing shareholder return maximisation behaviour.”

CEO pay levels are also strongly influenced by the recruitment process – executives hired from outside the company or the country will be paid more than internal hires.

Fair winds
Sarah Haydon, who took over as chairwoman of struggling carpet maker Cavalier Corporation in July 2015, says these issues come with clear challenges for boards.

“The reality is that CEOs often earn the most when they have a fair wind behind them,” she says.

“Yes, they’re executing a good strategy but they’ve got positive macro factors helping them along the way. Often the CEO will earn the least when the external environment is against them but that’s actually when they really have to pull out all the stops and show their mettle.”

Those conditions can be a problem for listed company boards, whose shareholders have little patience for paying a bonus when profits are low, Ms Haydon says.


Milford Asset Management portfolio manager Sam Trethewey says the best balance is when CEOs receive a lower base fee and have more at risk.

“You’ve got a CEO busting a gut, you’ve got your back to the wall as our CEO has, yet we can’t give him a discretionary bonus.

“A CEO in a listed company understands that keenly – no matter how hard they work, whatever the external environment the result is what it is,” Ms Haydon says.

“That’s why a lot of CEOs don’t want to be in a listed company. Private companies can give out discretionary bonuses based on what they see the CEO has done. A public company can’t really do that.”

Air New Zealand chairman Tony Carter says the key for boards is designing a practical mechanism to align CEO rewards with company goals.

“The problem with [total shareholder return] is it’s really just a long-term measure and the challenge for boards is a lot of assessment of rem [remuneration] is in short-term measures and you’ve got to try to correlate that with long-term measures,” he says.

“For boards it’s a really challenging subject and they are very aware of the social licence to operate and the cultural environment in New Zealand but, balancing that, we do have to attract good talent and reward them appropriately for great performance.”

Market concern
Boards are often advised on their pay structures by consultancies such as Auckland-based Strategic Pay, whose chief executive John McGill acknowledges the weak relationship between CEO pay and company performance.

“There is usually a positive relationship but it’s nothing to write home about,” he says.

“It does cause a lot of comment and concern in the marketplace. There are some good reasons and some not so good reasons why we see what we see.”

In no particular order, those reasons can include time lags between the factors influencing company performance and reported pay, poor communication by boards and soft incentive targets.


Castle Point co-founder Stephen Bennie says CEOs can "literally be worth their weight in gold."

“When it comes to the setting of targets I know for the boards I advise it really is difficult to relate this year’s good results to the actual payouts. [For example] it may be they’re on a long-term scheme and the shares don’t vest,” Mr McGill says.

“Some of these things, if you’re a member of the NZSA, you might regard with a lot of scepticism. ‘What’s going on? Either there have been good results or there haven’t’. Unfortunately, it’s not as simple as that.”

In October a new NZX Code of Corporate Governance came into effect, which should improve company disclosure around executive incentives, says Mr McGill, but there is still some way to go.

Exactly what a CEO’s key performance indicators are is still often a mystery for shareholders.

“It’s really in the incentive pay component we need to do more work, and boards need to better communicate what they’re doing and why.”

Top returns from Tourism Holdings
Campervan company Tourism Holdings delivered the highest total shareholder returns on the NZX in the five years to June in an emphatic endorsement of strategic change under chairman Rob Campbell and chief executive Grant Webster.

Analysts and investors pick several common factors behind its remarkable performance.

Forsyth Barr’s Andy Bowley identifies three: favourable tailwinds from resurgent tourism demand; the 2012 merger with Kea and United; and a staunch focus on return on capital.


Tourism Holdings CEO Grant Webster enjoys good guidance but has "executed very well."

“The chairman is very focused on Rofe [return on funds employed] and therefore everything they do from a capital allocation point of view and business initiative point of view comes with a Rofe-type objective,” Mr Bowley says.

He points to THL’s Flexfleet initiative, which accelerates the purchase and sale cycle for its vehicle fleet, reducing the time capital is tied up during the low season.

Mr Webster’s ability to deliver on those measures was crucial, Mr Bowley says.

“Grant lives and breathes THL and has clearly executed given the success of the initiatives that have been introduced.”

Portfolio manager Sam Trethewey, whose funds at Milford rode those gains after loading up on THL stock in September 2013, says the company was on its knees and needed restructuring.

“They’ve deleveraged the business, reduced the volatility of the earnings through some smart ways of managing their fleet and optimised their fleet a lot.

“I’d say Rob’s empowered the chief executive to achieve what he has and guided him through it. We rate Rob highly,” Mr Trethewey says.

“Grant Webster has had good guidance but he’s executed very well.”

THL’s annual report shows Mr Webster’s pay in the year to June was $1.04 million, comprising $528,000 in base pay, $396,000 in short-term incentives and $87,600 in long-term incentives in the form of share options, plus KiwiSaver of $25,688.

Mr Campbell said Mr Webster’s pay was designed to reward good performance but it was only part of the story. 

“Grant is a very driven and skilled CEO. I love working with him and we are achieving outcomes which he and I have worked on with other board and management,” Mr Campbell says.

“Grant’s remuneration is skewed toward financial reward from achieving our goals. I think he is driven by this in part but also strongly by his personal sense of achievement.”

Cavalier Corp bottom of the pile
Carpet maker Cavalier had a tough five years, delivering a total shareholder return of minus 76% according to Bloomberg data. It would have been lower but the company did pay a couple of dividends along the way.

Chairwoman Sarah Haydon, who took on the role in July 2015 after joining the board in August 2012, says Cavalier, once a high performer, struggled to cope with change after the global financial crisis.


Cavalier Corporation chief executive Paul Alston chose a challenging gig for his first CEO role.

“In a nutshell, after the GFC the market in New Zealand for New Zealand-made goods in general – and particularly New Zealand-made goods out of New Zealand commodities like wool – basically underwent a seismic shift. All of a sudden New Zealanders became keen on synthetic fibres, prices went down. There was a seismic shift in our industry and Cavalier was relatively slow to react to that.”

For a vertically integrated manufacturer like Cavalier, change was slow and painful to achieve.

“What caught the company unaware was just how quickly New Zealanders would adapt. Ten years ago over 80% of carpet sold in this country was New Zealand wool. Now it’s less than 20%.

“And, of course, all Cavalier’s manufacturing was set up for wool. We have a complete supply chain, we own the scours, the yarn plants. And for an integrated company it’s actually harder to make those changes, especially when you’ve got maximum debt, so we were in pretty poor shape five years ago.”

Chief executive Paul Alston was appointed in May 2015 after joining the company as chief financial officer in late 2012. An accountant with investment banking and company turnaround experience, Mr Alston chose a challenging gig for his first CEO role.

Cavalier’s annual report indicates Mr Alston was paid $500,000 in the year to June but it doesn’t break down his pay structure.

Ms Haydon says there are incentive payments in the structure based on a mix of qualitative and financial targets but financial targets must be met before qualitative incentives kick in.

However, Cavalier’s financial position strongly affects the overall pay level.

“I suspect we’re paying around the minimum and our pay is structured so that, of course, his ability to earn a lot more money is directly and indirectly linked to the share price – primarily linked to a short-term incentive, which is based on current year results, which in itself drives share price and the long-term is based on the share price and shareholder returns,” Ms Haydon says.

“The other thing that’s important in our case is we appointed an internal candidate and it’s his first CEO role. If we had to tempt someone else from outside, we probably would have started much higher.”

High pay in Sky TV’s low return world
Pay-TV company Sky TV was among the bottom-10 performers over the five years to June, with a return of just 12% – but paid its chief executive John Fellet one of the highest sums in the survey.

Sky’s annual report shows Mr Fellet’s pay for the year to June was $2 million, comprising base pay of $1.4 million and incentive pay of $559,611.

The incentive structure has been the same for 16 years and the CEO’s bonus is based only on return on capital, although KPIs for other executives include measures such as customer churn or staff turnover.

“Historically we took the view that other measures such as customer satisfaction, staff turnover, etc will ultimately be captured in the return on capital employed,” Sky chairman Peter Macourt says.


Sky TV board considers chief executive John Fellet's pay to be reasonable.

Since the board identifies the company’s value as the net cashflow it produces over its life, that is the measure its incentives are designed to promote.

“There is a fundamental difference in the way this system works when compared to the share market,” he says.

“That is, the pay structure rewards on actual performance whereas the share market reflects future expectations.”

Sky’s board is comfortable that the CEO’s pay is reasonable, Mr Macourt says.

“I can only assume the perception John’s pay is high is based on share price performance rather than actual return on capital employed. 

“I should note that, in terms of relative performance, Sky has outperformed all other New Zealand-based traditional media companies by a substantial margin. Also, John’s base pay is certainly not high in comparison with Australian and overseas comparatives.”

Mr Macourt says Sky has been affected by competition from the likes of Netflix and Apple and lost subscribers to lower-cost internet offers.

However, changing the CEO’s pay structure wouldn’t make a difference to the way Sky addresses those issues, he says.

“We still want the Sky executive team to be focused on increasing the level of net cash generation over time and, given the increased complexity of the overall market, we think we need the very best people to address those issues.

“The market perception of the outlook for Sky and the underlying share price might be quite volatile given the various competitive threats but the board believes we need to continue to attract the best executive team possible to confront those issues.”

Air NZ in the sweet spot
The highest pay in the survey went to Air New Zealand chief executive Christopher Luxon – but you’d be hard pushed to find anyone who says he wasn’t worth it.

The airline delivered a total shareholder return of 621% over the five years to June, including dividends, the third-highest return on the NZX.

Over the same period it consistently paid its CEO more than other companies in the survey, and in the year to June Mr Luxon received pay and bonuses worth $4.7 million.


Air New Zealand chief executive Christopher Luxon is the highest-paid CEO in the survey and also one of the most highly regarded.

According to the annual report that sum comprised base pay of $1.5 million, plus a further $1.5 million in short-term incentive and long-term incentive pay in the form of share rights valued at $1.6 million. Pension contributions added a further $125,080.

The performance incentives are based on a mix of financial and non-financial targets such as leadership and culture. The CEO is required to hold shares worth 55% of his base pay to participate in the long-term incentive scheme.

Chairman Tony Carter says financial returns are not the only measure of CEO performance.

“Clearly a role is to deliver returns to the shareholder but there are other things that go to a more long-term focus on shareholder value – things like sustainability, diversity, culture survey results, which are equally important, probably a little more subjective, but also go to a long-term overall assessment of the CEO.”

Whether incentive payments are a significant driver of behaviour will depend on the individual, Mr Carter says but for Air New Zealand the package was part of the deal to get the board’s choice of executive.

“It’s a very complex organisation and clearly you have to go global to attract the best talent.

“Christopher was attracted back from Unilever in the US and I think he’s done an outstanding job but the reality is, if he’d stayed in the US he’d probably be earning a lot more than he’s earning at Air New Zealand.”

Mr Carter says Air NZ has benefited from tailwinds in the form of low fuel prices and external factors always influence company performance “but last year we faced unprecedented competition from international carriers and still delivered our second-best year ever.

“I would argue the management team had a very significant influence on the financial performance. Qantas has done really well but a lot of the other global carriers have really struggled in this environment.”

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2 Comments & Questions

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A very shallow look at executive pay, consisting mainly of anecdote supplemented by some data analysis one could drive a double-decker bus through. To take just one example, estimating the correlation between shareholder return and pay levels is nonsensical due to size differences alone. Selection biases (firms facing difficult trading conditions pay a lot to get the CEO who they think will minimise the pain) are also unaccounted for.

Economics and finance researchers, including some in NZ, have spent decades looking at the CEO pay-performance issue, but you wouldn't know it reading this article.

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Thanks for your comment Steven. It would be ludicrous to claim this is a rigorous statistical exercise - and I don't. The point is to talk about the issues that affect how companies pay their CEOs and what affected the performance of companies in the survey. You will notice that very little space is spent in the article talking about the survey itself - most of the article is about what people who are directly involved in business think about the relationship between pay and performance, particularly when it comes to specific companies. The whole point is to look behind the crude figures and discuss some of the issues - hence the concentration on comment rather than statistics.  

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