(June 10): The subject of remuneration has always been one of fascination. We are naturally curious about how much our friends, colleagues, boss and competitors are being paid. In the US, mainstream news media such as The Wall Street Journal publishes annually a list of how much CEOs of the biggest listed companies — the likes of Bob Iger, Elon Musk, Mark Zuckerberg, Warren Buffett and Larry Page — earn.
Next week, The Edge Singapore will carry a similar article, listing the 40 highest-paid CEOs for companies listed on Bursa Malaysia and the Singapore Exchange.
Remuneration in absolute terms by itself is not very meaningful. Therefore, the study goes on to measure remuneration against several key metrics, including the company’s net profit, total staff costs, market capitalisation as well as total shareholder returns over the same period.
There is no one “best” metric. Oftentimes, that depends on your perspective. As a shareholder, you would be most interested to know how much the CEO of your company takes home, compared with how much profit the company makes and your total returns for holding the stock (dividends plus capital gains).
You might be interested to know that there was little, if any, correlation between CEO pay and returns for shareholders in FY2018.
Shareholders are often told that it is the board of directors that is fully cognisant of the efforts of management and, therefore, they alone should determine how management should be paid. I disagree. It breeds incestuous relationships.
A common approach has been to use consultants as third and independent party. Given that the management and the board appoint these consultants, their independence should be questioned.
Furthermore, it often leads to a wage spiral as consultants tend to use the comparison approach. Company A is compared with Companies B and C. If the CEO of Company A is paid lower than those of Companies B and C, his pay is adjusted upwards, causing the industry average to go up. The subsequent effect is to push up the CEO pay of Companies B and C… and it goes on and on.
Look out for The Edge Singapore next week. For one listed company, three brothers who are executive directors and controlling shareholders took 14% of the company’s net profit as their compensation in FY2018, which accounted for nearly 4% of its market capitalisation. The company has not declared dividends for years, and the stock price and reported profits have fallen in the last two years.
Another company gave its CEO a 37% increase in pay in 2018, while shareholders saw -80% returns, from a reported profit in 2017 to a huge loss in 2018.
The point of this article is not to criticise any CEO or their pay scale. But I do believe that public listed companies have an obligation to shareholders. The board should decide on the appropriate compensation, but it must also be transparent and articulate how the salaries are determined, based on clearly defined performance metrics. An excellent CEO should rightly be paid more.
Let me use the compensation framework for Avarga (listed on the SGX), as outlined in its latest 2018 annual report, as an example. We have a clear approved framework from the beginning of each year, stating the targets, the formula to calculate pay and bonuses, and how these financial variables are determined. And, taking into account the agreed risk parameters, the required profit and cash flow return objectives. Broadly, the framework goes like this:
1. A risk assessment matrix is undertaken at the start of the year. Each operating business entity is assigned a risk score out of 20, based on the outlook for earnings sustainability, performance risks, country risk and currency risk. The scoring is also relative to the past.
2. An agreed required rate of return for each risk profile, established objectively and approved by the board of directors.
3. Multiplying this required rate of return with the percentages of total capital employed for each of the business entities would yield the overall weighted required rate of return for the company.
4. To this is added the prevailing risk-free rate of the market, which is what could be earned if the entire capital is invested in risk-free assets such as government securities.
5. Finally, the required rate of return is topped up with a gearing multiplier, since a higher gearing will raise overall risk profile. This encourages management to use debt prudently.
6. For 2019, management compensation is based on exceeding a hurdle rate of 8.52% of total capital employed. Note that this rate is in fact higher than the weighted average cost of capital of 5.8% that is derived by Bloomberg.
The framework and parameters I have outlined for Avarga may not necessarily be right or right for all companies, but they are intended to be comprehensive, transparent and quantifiable.
What is the recourse for minority shareholders when confronted with an outsized compensation to the CEO who is also the controlling shareholder? What happens when the company decides to pay no dividend, but streams out cash flows as compensation?
One might argue that minority shareholders can sell their shares. But why should fiduciary responsibilities be set aside where there might be a clear conflict of interests? Is there a need for regulatory oversight?
My Global Portfolio rose 1.6% this week, slightly better than the MSCI World Net Return Index’s 1.5% gain. This raised total returns to 4.3% since inception. This portfolio is still outperforming the benchmark index, which is up 2.7% over the same period.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
This story appears in The Edge Singapore (Issue 884, week of June 3) which is on sale now. Subscribe here
