Dialogue: Directors' pay must be tied to company performance

By DAVID ZWARTZ*

There are obviously two ways of looking at directors' fees. The first is what directors themselves think they should be paid. The second is what other people with an interest in the company think.

Directors themselves, quite naturally, are interested in getting as much as they can. In this they have the support of the Institute of Directors which, like every good union, tries to get the best possible money and work conditions for its members.

This can be clearly understood from its well laid-out website (www.iod.org.nz).

The institute establishes the structure for the occupation of director as a profession. There are guidelines for best practice in a wide range of practical, legal and ethical issues, opportunities for training, and so on. This is similar to the professions of medicine, law, engineering, teaching and others.

There can be a major difference, though, when it comes to assessing what different professionals should be paid.

You come face to face with your doctor, dentist, lawyer and accountant. You can make a direct assessment of how good they are and what they are worth to you: they cure you, or they don't; fix your toothache, or don't; defend you successfully in court, or don't; get your income tax return in on time, or not.

It isn't like that with the directors of the companies people invest in. Only a tiny minority of shareholders attend an annual general meeting, see their directors in the flesh, and hear what they have to say.

That leaves people who have entrusted their investment capital to the care of directors with only one way to decide how much they think those directors should be paid - the success (or otherwise) of the company.

If the company performs well and the results please the shareholders, they will not mind increasing the directors' fees. If it doesn't perform well, shareholders are fully entitled to say that the directors don't deserve an increase.

It is the shareholders' investment money, and what the company has produced with that investment, which is paying the directors' fees.

It might be argued that the desire of shareholders to get a good return from their investment is no different from the desire of directors to get high fees for what they do. But there is a major difference between the power of shareholders and that of directors to influence the return they get.

Small shareholders have negligible power to direct a company's fortunes. The return they get is controlled totally by the directors. Directors, on the other hand, are in a good position to decide their own remuneration, supported by their union and other influential and self-interested groups.

It is the apparent abuse of directors' powers to reward themselves that has set off recent shareholder reactions.

The system for setting directors' remuneration touted by directors and companies, which amounts to comparing them with themselves, is designed only to produce an upward fee spiral without regard to performance.

The fact that the "reviews" are provided mostly by organisations linked to appointment agencies is in itself suspect.

Comparison with other companies doesn't come into it. If directors feel underpaid they can resign and go elsewhere.

"Market forces are what determine directors' remuneration," say some. "If we don't pay them enough we won't be able to attract good directors."

It is true good company directors need to have business acumen and experience, understanding of our society and empathy with their company's customers and shareholders. These qualities are worth paying for.

But shareholder sentiment and shareholder assessment of a director's worth is also a market force, and an important one. Without shareholder confidence a company will suffer.

In the case of Contact Energy, shareholders saw the directors (who admittedly had not received an increase the previous year) asking for a 38 per cent rise for the chairman and 42 per cent for other directors, without evidence that it was deserved.

A so-called independent review was used to help fix the new fees level. The part of the review I have seen is statistically pathetic.

The reason I say "so-called" is because the opening sentence of the review's final page begins: "In summary, the data provided by Korn/Ferry's Board of Director Study for 2000 supports the board's intention to propose raising the fees ... " As I read this, Korn/Ferry was asked to provide a justification for the Contact Energy board's intention to raise directors' fees, rather than provide an independent or objective appraisal.

But the final sentence in the review's recommendation is interesting: "Remuneration is a critical element in attracting an effective, knowledgeable and cohesive board who can rise to the challenge of meeting the growing demands for greater accountability and more effective company performance."

When shareholders see a lack of accountability, and less-effective company performance, who can blame them for not wanting to reward their directors?

* David Zwartz is a small shareholder in Contact Energy.

Links

Institute of Directors in NZ