Low Fees Reflect Conservatism

There are few occupations that are completely free in deciding how much to pay themselves. In theory, the occupation of director is not one of them. When a board or board committee sets director remuneration, it must be allowed to do so by the company’s constitution and the settings must be “fair” to the company. Remuneration of directors of listed companies requires shareholder authorisation. Best practice speaks of the need for directors’ remuneration to be fair, reasonable and transparent.

In practice, what is “fair” can of course be the subject of some debate. For listed companies with widely held share ownership and chairmen exercising many proxy votes on behalf of absent shareholders, shareholder authorisation of remuneration levels can have a large element of pre-determination. In closely held companies where ownership and control overlap significantly, directors can usually decide how much to pay themselves (and rightly so) with little to no outside interference. For publicly owned entities clear governmental guidelines exist. Does this mean that New Zealand shareholders have suffered excessive director remuneration over recent years?

“Not at all!” is the clear message from the freshest data available. The just released 2006 Directors Remuneration Survey from the Institute of Directors and Strategic Pay Ltd shows that over the past 10 years the annual rate of base fee increase for non-executive directors has been 3.3% and for chairmen 4.5%. Median fees in 2006 were $26,500 for non-executive directors and $38,500 for chairmen. This is scarcely an immoderate or excessive trend and reflects rather a degree of conservatism when one considers the sample as a whole.

Similarly a rolling three year trend of median increases reveals that both chairmen and director increases have declined to 3.2% and 2.2% per annum respectively in the 2004-2006 period from earlier highs in the 2001-2003 through to the 2003-2005 periods. One interpretation is that these highs of between 5% and 7% median increases were occasioned by the removal of retirement allowances and the payment of compensatory increases. Retirement allowances for directors have steadily fallen out of favour. Director remuneration should be based on performance and contribution as opposed to length of service. There have been some large increases in a small number of companies and these can skew average increases as opposed to median increases.

What is one to make of this picture? Clearly, there is no overall culture of excess here. Whether this conservatism is a good or bad thing depends on your point of view. If the purpose of remuneration is to recompense effort, reward skill and motivate performance then a trend of low increases tends to suggest either unspectacular performance in an important role or reward for satisfactory performance in a narrowly prescribed role. In terms of the risk-return trade off it suggests New Zealand directors have been rewarded on the basis of low risk decision making and conservative “safety first” performance.

This column has reiterated on several occasions that the prime function of a board is to add real value across four pillars of good governance: accurately determining purpose and strategy, holding management to account, operating as a high performance team and ensuring effective compliance. The best thinking on current board performance is that directors need to play more informed and meaningful roles in a company’s governance not just limited to ensuring compliance with regulation and orthodox practice. To the extent one argues that it is precisely this narrow compliance focus which has characterised recent New Zealand board performance, then the latest remuneration figures might provide a degree of support.

The danger here, in these post Enron times, is that risk averse directors will continue to be less than they can be, or should be, in directing their companies. With talk of economic transformation and the need to grow our businesses to a scale where international success and competitiveness can be more frequently encountered, it is jarring to see low levels of director remuneration reflecting perhaps comfort with a lower risk and lower return environment. Some might term this proper conservatism, others might see entrenched mediocrity.

The Institute looks forward to a time when directors in New Zealand are remunerated for adding value to their companies across the four pillars of good governance. In such cases, directors, their companies, their shareholders and the national economy can celebrate a genuine “win win” result.