Culture and remuneration

Nobody doubts that board workloads are rising as directors dig deeper into organisation culture after the Financial Services Royal Commission. Less considered is whether board fees should increase, after years of small gains, to compensate directors for extra work.

Proponents of higher pay say directors are underpaid relative to executives, partners of large professional-service firms and consultants. Fees should rise faster because stakeholders and regulators want more of boards, and for directors to hold fewer roles.

Also, board committees’ workloads have increased significantly in the past five years and it is common for directors to attend meetings of committees they are not members of, to better understand issues that affect other committees and the organisation. Chairing an ASX 100 Audit and Risk Committee has become a significant role in its own right.

Critics say listed-company directors are well paid for what is a part-time role; that comparisons with executive or consultant pay are irrelevant; and that many directors chose the role as much for the intellectual stimulation, networking and work/life balance, as pay.

“Investors would be open to a debate about higher board pay, provided boards can demonstrate extra pay leads to better governance outcomes,” says Martin Lawrence of proxy advisory Ownership Matters. “Some of the worst governance failures in recent times involved directors who were among the highest paid in Australia. Insufficient board pay wasn’t the issue.”

Lawrence believes board fees are about right. “Looked at from the outside, ASX 100 companies seem to have little problem finding suitably qualified directors. Where else can someone earn $200,000 a year for working a day a week and have as much flexibility? Comparisons with executive or consultant ‘day rates’ are meaningless because most directors don’t want to work 16-hour days anymore.”

“It’s not clear how many hours directors are expected to work in their role, or how that workload breaks down between different board tasks. I’m not saying boards should report every hour a director works, but there’s scope for better reporting on what is expected of directors and how much time they put in across different tasks.”

Lawrence rejects claims that directors should be paid for higher workloads after the Royal Commission and the Australian Prudential Regulation Authority’s (ARPA) report last year on the Commonwealth Bank. “Frankly I’m surprised that bank boards weren’t doing that type of work on organisation culture before the Royal Commission. This so-called extra work is what directors should have been doing in the first place to understand culture and risk. It’s hard to argue that boards should now be paid more for that work.”

Lawrence says lack of transparency is the underlying problem with board pay. “It’s not clear how many hours directors are expected to work in their role, or how that workload breaks down between different board tasks. I’m not saying boards should report every hour a director works, but there’s scope for better reporting on what is expected of directors and how much time they put in across different tasks. That would help investors better assess fees.”

Debates on director pay are complex and rife with generalisations. The perception that directors earn a six-figure annual fee for attending a dozen or so meetings each year (including committees) is misguided. Many directors receive modest income from board fees.

Pay varies widely across sectors: most listed-company directors are paid; about 80 per cent of private-enterprise directors are paid; and just over a third of government and not-for-profit directors are paid, according to the AICD Remuneration Survey 2016.

The average board fee for the listed sector was $87,604; in private enterprise it was $53,777; for NFPs, $25,930, found AICD. Listed-company fees varied greatly by organisation size: a director of a company with more than $2.5 billion in assets earned $161,271 on average.

Board fees fall sharply beyond the ASX 100. A NED in an ASX 101-200 company earns a little over half of his or her peers on a top-100 board. Clearly, debates about high board fees are mostly centred on a small group of directors in the largest listed companies.

Case for higher fee growth

Also, increases in listed-company board fees in the past three years have barely matched inflation, according to remuneration and governance consultant Egan Associates. Some boards of financial-services organisations have taken pay cuts to demonstrate their accountability for governance problems and acknowledge that directors are not immune to consequences for poor performance.

The upshot is that board fees have remained largely static at a time of rising workloads, greater stakeholder expectations of boards, and higher legal, financial and reputational risks for directors – a trend that Egan founder and CEO John Egan believes potentially warrants a board pay rise in some settings of up to 30 per cent. Egan is one of Australia’s most experienced remuneration and board consultants.

He says the increase should be applied to ASX 200 boards on a case-by-case basis, be spread over three years, and issued through share rights that vest when a director leaves the board.

“It doesn’t feel right if the Chairman of an ASX 50 company earns $500,000 for working at least two days in the role each week and the CEO earns $4 million,” says Egan. “Nor is it appropriate if an NED earns $200,000 a year and a senior executive is earning well over $1 million. If we expect directors to spend more time in the role, we need to ask if their fees are still appropriate after years of modest increases.”

Egan believes directors of government enterprises should receive higher fees and that more not-for-profit organisations should pay board fees. “The work that boards of government organisations do is incredibly important, yet their directors typically earn a fraction of what a listed-company director makes. Many NFPs rely on volunteer directors who want to give something back to the community, but these roles require time and skill, and have risk.”

Egan has noticed three core changes in boards after the Royal Commission and APRA’s CBA report. The first was a recognition among some directors that extra work was needed on organisation accountability. “Frankly, some boards are doing more work now because they weren’t doing enough in the first place,” says Egan. “The Royal Commission was a wake-up call that boards are ultimately responsible for the organisation, its culture and behaviours.”

Greater focus on organisation sustainability was the second change, says Egan. “Too many boards relied too heavily on financial information and did not spend enough time understanding non-financial issues, such as culture, which go to the heart of sustainability. I see directors now elevating their oversight of risk and spending much more time on it.”

The third change was verifying management information. “Boards for years have relied on information management provides, to make decisions. In some cases, boards have received inaccurate or incomplete information, or management has filtered the data. There’s a growing recognition among boards that they need to spend some time verifying information and sourcing external views as a second opinion.”

Egan says these combined changes have greatly increased workloads for ASX 100 boards. “The director of an ASX 50 company who spent 50 days each year on the role might now spend up to 75 days as the board’s responsibilities expand. In that context, $250,000 for a very experienced director is not that high on a daily rate compared to other fields that require senior business people, particularly given the legal and reputational risks involved with the role.”

Moreover, as board workloads increase, directors are expected to hold fewer roles, to avoid the practice of “overboarding”. Proxy advisers and institutional investors have focused on director workloads and some have blanket limits on how many roles directors can hold. They believe directors who hold too many roles are less effective and have insufficient flexibility should a crisis strike and the board role becomes almost full-time.

“If career directors have to hold one or two fewer board positions to keep investors happy, and they are relying on the fees to maintain their lifestyle, it’s a big hit to their income,” says Egan. “If the market wants directors to serve on fewer boards, and spend more time in each role, then we need to ask if each role should come with higher fees.

Egan adds: “In the above context, investors will focus increasingly on board and individual director capability (to govern culture) and expect that the disclosure of capability matrices extends well beyond a series of one or two-word descriptors, with increasing disclosure in individual director profiles highlighting the relevance of their background to the tasks of the board in their governance oversight.”

Competitive fee pool needed

Michael Robinson, a director of Guerdon Associates, a leading remuneration and board adviser, says ASX100 boards will need higher fee pools to recruit high-quality directors. “There is a push from investors for boards to have more directors who are industry specialists and/or more women. That means recruiting former executives who can still command high salaries.”

Competition for former CEOs who can transition to boards is rising, says Robinson. “In years past, an ex-CEO joined the board because he or she wanted to stay active in business and was happy with less income. It’s much harder for boards to attract top former CEOs these days; they can see that director workloads are rising, director pay is not great relative to what they can earn elsewhere, and there is a lot of potential risk involved in governing large organisations.”

Private equity is another consideration. “The available pool of former CEOs shrinks as many join private-equity boards,” says Robinson. “An ex-CEO can earn a lot more on a private-company board through leveraged equity incentives; can apply a laser like focus to maximising shareholder return in a specific five-year time frame without the distractions of six-monthly results announcements; and does not have all the compliance and regulation that comes with governance of ASX-listed companies. ASX300 boards will increasingly struggle to compete with private-equity for former CEOs if director fees stagnate and regulatory burdens increase.”

Competing for international directors will also become harder. As Australian companies globalise, they may need to source offshore-based directors with international experience. “US boards generally pay significantly higher fees than Australian boards do, for less work,” says Robinson. “Again, it becomes hard for our boards to compete for top director talent if our fees are not internationally competitive.”

Although there are clear arguments for higher board pay, Robinson says it is a difficult environment to argue for higher fee increases. “It would be hard to get support from external stakeholders given the governance issues in financial services and other sectors. This is somewhat surprising because as company valuations increase, and organisations become larger and more complex, it stands to reason that the amount spent on governance should rise. Paying a bit extra for the board is a small cost for better governance of a multi-billion-dollar company.”

Robinson says it is ironic that risk officers and governance specialists are among the most in-demand fields in corporate Australia, but board pay is flat. Chief risk officers at Australian banks are now among their organisation’s most powerful and highest-paid executives, and compliance officers generally are in higher demand as the regulatory landscape changes.

“Companies are paying a lot more for governance and risk experts at the executive level, but nobody wants to pay extra for that skill at board level,” says Robinson. “We’re asking a lot more of boards for essentially the same pay. At some point, listed-company boards will become less attractive to the best directors if growth in board fees does not improve.”

Tony Featherstone is Consulting Editor of the Governance Leadership Centre and a former managing editor of BRW and Shares magazines.