Outrageous fortune: What skyrocketing executive pay means for inequality

by Rebecca Macfie / 11 May, 2017
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The average pay for New Zealand’s top bosses has surged to over $1 million a year. So what impact is this having on the gap between the haves and the have-nots?

Nick Grayston, chief executive of big-box retail chain The Warehouse, makes more in two weeks than Michael*, one of his Christchurch shop-floor employees, earns in a year.

Michael, who is 26 and has worked for the company for six years, is on $18.81 an hour. He says his wage for a 36-hour week is enough to get by on – it pays the rent (although he sees little prospect of being able to afford to buy a house), pays the loan on his motorbike – his only form of transport – and covers expenses. He has a partner who works, and they have no children.

“It’s close to the living wage,” he says of his hourly rate, which the company classifies as the “career retailer” pay. His annual income works out at $35,212.

Grayston, on the other hand, brings in a base annual salary of $1.4 million, plus a bonus of up to $700,000 if he meets short-term incentive targets; further long-term incentives will accrue after 2019. Despite the size of his pay packet, Grayston says money was a “secondary factor” in deciding to move his family from the US to take up The Warehouse’s top job. “First and foremost was a belief in the company, its strong heritage and role in New Zealand communities, its governance and its culture,” he says.

For his part, Michael is not unhappy with his employer, despite his modest pay. “I think they try to keep us happy.” Nor is he angry about the wide discrepancy between the earnings of those on the shop floor and Grayston. “It’s more disappointing really … You just feel they could give us a better go.”

The University of Otago’s Helen Roberts. Photo/Guy Frederick

The gap is getting bigger

According to an 18-year body of research by University of Otago accounting lecturer Helen Roberts, the gap between the wages earned by people like Michael and those of New Zealand’s top company bosses has been steadily widening.

In 1997, Roberts began tracking the pay of the chief executives of companies on the New Zealand stock exchange (NZX), following a change to the Companies Act that required listed firms to disclose all salaries above $100,000 in bands of $10,000. Over time, some companies have dropped off the NZX as a result of a takeover, merger or failure, but the size of her sample has remained steady at 75-80 companies. She excludes companies in the finance and banking sector because their balance sheets are not readily comparable with other companies.

Her latest update of the data, completed this month, captures movements in chief executives’ pay up to the end of the 2015 financial year.

She found the average annual cash remuneration received by company bosses in 2015 was $1.06 million. After adjusting for inflation, that’s an increase of 228% on the 1997 average of $324,000. The annual average rate of increase works out at 7%.

Over the 18 years of her study, Roberts has compared chief executive pay with the average annual incomes of the workforce as a whole, as measured by the Statistics Department’s New Zealand Income Survey. In 2015, the average income was $57,117 a year, having increased by 91% since the 1997 inflation-adjusted average of $29,900. That works out at an annual rate of increase of 3.7% – just over half the rate enjoyed by those at the top.

When Roberts began her research, the average chief executive was paid 11 times as much as the average income earner. According to her latest data, that pay multiple has inflated to 19 times (see graph page 20).

However, Roberts says her data gives a conservative picture of the pay gap between bosses and average workers, for two reasons. The New Zealand Income Survey includes all wage and salary earners, including highly paid executives, which drags the average up. And the exclusion of banks from her sample depresses the average chief executive pay rate, because in recent years, bank bosses have been among the highest-paid. ANZ NZ boss David Hisco, for instance, was on $4.06 million last year.

Roberts’ sample also excludes Fonterra because it is a co-operative and not fully listed on the NZX. Its chief executive, Theo Spierings, was paid $4.6 million last year.

At the level of individual companies, the ratio between top pay and shop-floor wages is often much higher than the average reflected in Roberts’ calculations. According to First Union, which represents ANZ Bank workers, the average salary is $60,000; Hisco’s annual pay is more than 67 times as much. At The Warehouse, assuming Grayston achieves his short-term bonus and receives a total cash salary of $2.1 million this year, his annual pay will be almost 60 times what his employee Michael earns in a year.

The Warehouse’s Nick Grayston.

Are they worth the top dollar?

So why has top pay gone up so much? And are those who receive the big bucks worth all that money?

In trying to find the answers to these questions, the Listener wrote to a sample of 12 chief executives of companies with securities listed on the NZX and asked them four questions: what the value of their annual remuneration package is; whether they feel it is an appropriate level of remuneration, and if so why; how many hours a week they work; and how their annual pay compares with the full-time-equivalent earnings of the lowest-paid person in their company.

Only three answered the questions (The Warehouse’s Grayston, Z Energy’s Mike Bennetts and Ryman Healthcare’s Simon Challies). Five did not reply (Briscoe’s Rod Duke, Vector’s Simon Mackenzie, Air New Zealand’s Christopher Luxon, Restaurant Brands’ Russel Creedy and Fletcher Building’s Mark Adamson). Fonterra’s Theo Spierings did not respond, but the company’s publicity department sent an email that did not answer the questions; Auckland International Airport’s Adrian Littlewood did not respond; his chairman, Sir Henry van der Heyden, sent a comment supportive of the chief executive’s performance and salary but did not answer the questions. The ANZ’s Hisco replied with information that did not answer the questions.

Grayston replied that his salary of $1.4 million plus up to $700,000 in short-term bonus was set by the board following a “benchmarking” exercise by an outside agency that ensured it was “right for the skills and international experience needed to take the business forward”. He works “many hours per day and I need to be available for my team 24/7”. He calculated his base pay (excluding bonuses) at 43 times the lowest entry-level wage in the company.

As chief executive of Z Energy, Mike Bennetts was paid $1.75-1.76 million last year ($750,000 of which was base salary and the balance performance bonuses), which he says is 38 times the earnings of the lowest-paid worker in the company. Bennetts says his pay is appropriate given the skills he has accumulated over 30 years working in New Zealand and overseas, and “the buck stops with me” for the operation of one of New Zealand’s largest commercial enterprises. He says it is appropriate that 60% of his remuneration is performance-related for achieving short- and long-term results.

“I also appreciate this is a substantial sum of money for someone working in New Zealand, albeit more modest in an international setting. I do not take any of it for granted … and am mindful of what it means to others who work at Z or in the broader community.”

Ryman’s Challies said his annual remuneration of $1.04 million was appropriate for his responsibilities in an organisation with 10,000 retirement village residents, 4500 staff and 14,500 shareholders, which is also one of New Zealand’s largest developers and construction companies. This week’s historic equal pay settlement will lift the wages of rest-home workers and caregivers, but Challies’ salary is still 31 times that of the company’s lowest-paid workers (including kitchen and laundry staff and housekeepers), who earn a full-time-equivalent annual wage of $33,280. Challies works at least 80 hours a week and is the 34th best-paid executive on the NZX despite Ryman being one of the five largest companies and the “best-performing stock on the NZX over the last 20 years”.

Ryman Healthcare’s Simon Challies.

Performance vs pay

However, the empirical evidence on whether increasingly large chief executive salaries are justified is far more ambivalent. A “stable and significant relation between pay and performance has yet to be established”, concluded the International Labour Organisation in a 2008 study, “The World of Work: Income Inequalities in the Age of Financial Globalisation”.

Roberts looked at the link between pay and performance in the companies on her dataset between 1997 to 2002, taking the 10 highest-paid and 10 lowest-paid chief executives and then mapping that data against the performance of their companies. The results were surprising.

“The ones who got paid the most were the worst performers,” she says. “It does raise the question: ‘Are these people being overpaid?’ My expectation would have been that the most highly paid should have been the best performers.”

Numerous international studies have also failed to find a correlation between top pay and top performance. A major 2015 review of the evidence by Alex Edmans of the London Business School and Xavier Gabaix of Harvard University noted that “a significant proportion of the variance of firm pay remains unexplained”. The fact that company size and chief executive pay have both trended upwards since the 1980s “does not imply causality”.

Another long-term study, by Carola Frydman of MIT’s Sloan School of Management and Raven Saks, a member of the Federal Reserve board of governors, looked at trends in executive pay from 1936 to 2005. Their 2010 study found a “weak relationship” between pay and company growth from the 1940s to 70s, when firms grew considerably but executive pay rates remained flat. Between 1980 and 2005, both executive pay and company size expanded at almost the same rate.

A 2016 study of the UK’s 350 biggest listed companies by Lancaster University Management School found chief executive pay rose 82% in the 11 years to 2014, to a median of £1.9 million. However, return on capital rose only 1% over the period. The researchers said pay was tied to “short-term” performance measures such as earnings-per-share growth and total shareholder returns rather than longer-term measures of value creation that relate performance to the cost of capital.

They concluded there was a “material disconnect” between top executive pay and “fundamental value generation” and return on capital.

University of Auckland economics professor Tim Hazledine has studied the pay of chief executives of New Zealand’s publicly listed companies and found that none of the increase in their remuneration can be explained by growth in the size of their companies. However, he found there was a link between growth in top pay and a swelling of the ranks of highly paid managers reporting to the chief executive.

Fonterra’s Theo Spierings. Photo/Getty Images

PR nightmares

Although the disparity between the pay of New Zealand’s top executives and ordinary workers is, on average, less than in the UK and US, the issue is causing rumblings of concern in some boardrooms. Felicity Caird, who leads the Institute of Directors’ governance leadership centre, says excessive pay and fees can erode public trust and confidence in business, and her organisation and company directors need to “front-foot” the issue.

Appointing and setting the pay of the chief executive are two of the most important jobs of company directors, and Caird says the institute is aware of rising concern internationally, including complaints from increasingly active shareholder organisations.

“Big numbers get big headlines,” she says, pointing to the recent controversy over the 23% pay increase received by New Zealand Superannuation Fund boss Adrian Orr. The hike took Orr’s pay to $1.02 million – close to the average pay rate recorded in Roberts’ dataset – and prompted criticism from Prime Minister Bill English.

In Australia, a political storm broke out recently over the salary paid to the boss of government-owned Australia Post, with Prime Minister Malcolm Turnbull describing the A$5.6 million received by Ahmed Fahour as “too high”. One estimate put Fahour’s wage at 119 times the annual pay of the average Australian postie. Fahour resigned shortly after the furore but insisted his departure had nothing to do with the criticism over his pay packet.

Such scandals are PR nightmares for company boards, but some directors see the issue of pay disparity between those at the top and those at the bottom as more serious than mere brand damage.

Australia Post’s Ahmed Fahour. Photo/Getty Images

Director and corporate insolvency expert Michael Stiassny links issues such as extremely high executive pay with upheavals such as Brexit and the election of Donald Trump. “We need to take account of the fact that a large proportion of society is struggling in these times, and the future looks unfortunately bleak for them. The responsibility of the corporate world to ensure that excesses do not occur is becoming more and more critical.”

Stiassny chairs Auckland electrical lines company Vector and Tower Insurance, whose chief executives are on $1.56-1.57 million and up to $1.25 million respectively. He doesn’t “wish to be despised by CEOs around the country or indeed those who work with me, but we must come to a debate around what is a fair remuneration for a CEO compared with the minimum pay paid to one of the workers employed in the business. There will need to be some rebalancing. What that is, I’m unclear. But I don’t think there is any debate that sooner or later this issue will just get more and more important for us to deal with.

“We are exceedingly lucky that we do live in God’s paradise and as a result we as directors and we as New Zealanders have been shielded from these issues for too long.”

Stiassny believes the Brexit and Trump votes reflect a feeling of marginalisation among many people and that excessive executive pay “gives them a right” to feel that way.

Former trade unionist-turned-company director Rob Campbell chairs retirement village operator Summerset, one of the few companies on the NZX that reports on the ratio between the chief executive’s pay and the median wage paid in the company. Summerset boss Julian Cook’s total pay packet of $856,620 was 21.5 times the median employee’s $39,838.

Air NZ’s Christopher Luxon. Photo/Victor Carter

Campbell says the company introduced the disclosure move last year in response to rising global expectations from investors for transparency about remuneration and to the tendency towards tighter legal requirements. In the US, the Dodd-Frank Wall Street Reform and Consumer Protection Act requires firms to report on the ratio between chief executives’ pay and the median workers’ pay in the company from next year.

“I think it’s probably particularly important in industries where there is a significant low-paid component in the workforce,” says Campbell. “There is a fairness aspect. You can’t have a rational conversation about whether what we are paying is fair if people don’t know what the data is.”

Campbell says the objective of directors is to pay the chief executive at a “fair and reasonable level” in relation to others in comparable jobs, “because if you don’t do that, they will be vulnerable to departing”. But he points to the impact of executive remuneration consultants, who “have a significant impact” on the way boards think about big salaries.

These advisers run surveys of executive salaries, often specialising in different industries, and then present that advice to boards trying to figure out how much to pay company bosses. But Campbell says such benchmarking exercises, which break salary bands into quartiles, have a tendency to push up top pay rates over time, because boards “don’t want to be seen to be paying the chief executive remuneration that’s in the bottom quartile … There is an inflationary tendency for people to focus their eyes on the upper quartile. And of course, if everyone is doing that, there is a natural escalator effect.”

He says boards need to fight against that “escalator” and retain rigorous independence from the advice of remuneration consultants. Boards have to consider not just whether the chief executive is genuinely likely to leave if the pay is perceived to be too low, but also internal relativities – between the chief executive’s pay and that of other executives, such as the chief financial officer.

“There’s not much that the average trade union official could teach the average chief executive about wage relativities.”

UK PM Theresa May. Photo/Getty Images

More disclosure wanted

The New Zealand Shareholders’ Association published a report last year calling for better disclosure of top salaries and how they are set, recommending the inclusion of five-year summary tables to enable investors to see the relationship between pay and performance, as well as details of “golden parachutes” when a chief executive’s employment is terminated and disclosure of the gap between the top and median pay in the company.

Association chief executive Michael Midgley says shareholder concern about executive pay and performance is exemplified by the two recent profit downgrades by Fletcher Building, a company run by one of the country’s highest paid chief executives. Last year, Fletcher boss Mark Adamson was paid $4.72 million.

Midgley says Adamson’s pay and the company’s performance are a “classic case of why a very bright light needs to be shone on all of this”.

In the UK, public debate about what top bosses get paid has been joined by Prime Minister Theresa May, who argues public confidence in the capitalist order is at stake. “For people to retain faith in capitalism and free markets, big business must earn and keep the trust and confidence of their customers, employees and the wider public,” she wrote in the foreword to a Green Paper on reform of corporate governance, including executive pay disclosure rules.

“For many ordinary working people – who work hard and have paid into the system all their lives – it’s not always clear that business is playing by the same rules as they are,” wrote May.

The UK Shareholders’ Association’s Executive Remuneration Working Group published a report last year concluding that the escalation in top salaries over the past 15 years has not been matched by the performance of listed companies. The ratio of the average pay of bosses in the top 100 companies and the average pay of full-time workers was 47:1 in 1998; in 2015 it was 128:1.

Britain’s High Pay Commission, an independent group that undertook an inquiry into top pay in the public and private sectors in 2011, found that the pay of some bosses had soared by 4000% in 30 years. Written five years before the shock Brexit vote, the commission’s report, “Cheques with Balances”, says excessive pay damages public trust and undermines employee motivation, warning that a widening gap between the “haves and have-nots” could lead to political instability.

The commission also condemned as a “myth” the oft-heard argument from company boards that executive pay has to increase to attract the best talent from abroad, noting that global mobility among executives is “limited”. It described executive pay setting as a “closed shop” and said the public is “rapidly running out of patience with a system that allows those at the top to enrich themselves while everyone else struggles to make ends meet”.

Weighing into the debate last year, then chief of the UK Institute of Directors, Simon Walker – a former New Zealand broadcaster – questioned whether the escalation in pay for those at the top meant that people running today’s companies were “vastly more intelligent or efficient than they were 20 years ago” or “whether they would be any better or worse at the job if they were paid half as much”.

Walker drew a direct link between the gulf between executive and worker pay and the election of Trump and Britons’ rejection of the European Union. “Both of these seismic shifts show [that] large companies have failed to see their enlightened self-interest … If the public does not feel the current system is working for them, they will express their will at the ballot box.”

The inequality question

But New Zealand Initiative economist Eric Crampton warns against importing foreign narratives into the New Zealand conversation about executive pay, given the lower level of pay disparity here than in the UK and US. Indeed, he says it could be a problem for New Zealand if people with the skills needed to run large global companies – “where small differences in CEO talent can make a big difference for the firm’s bottom line” – all get sucked into the US or UK.

He says public concern about top pay is related to growing discontent about economic inequality. But he cites data from 1991 to 2014 showing New Zealanders have “broadly shared” in economic growth, with the incomes of the bottom 20% of earners, median earners and the top 10% all receiving similar rates of increase – although, as Roberts’ data attests, income growth among the top 1% of earners has been higher. In the US, by comparison, the pattern has been of stagnant median incomes and “exploding” incomes at the top, Crampton says.

He argues poverty in New Zealand is the result of escalating house prices – the benefits of which flow solely to those who already own houses – rather than in disparities between top and bottom pay levels. He says this is illustrated by data showing child-poverty rates before housing costs are taken into account dropped from 18% in 1982 to 10% in 2014, but after housing costs are included, child poverty increased over the same period from 12% to 17%.

Analysis by the Ministry of Social Development’s Bryan Perry shows that income inequality increased rapidly between the late 1980s and late 1990s, but the trend since then has been relatively flat. Perry’s analysis also shows the top 1% of New Zealand earners captured 8% of all taxable income in 2010 and 2011, which is similar to the situation in Norway, France and Australia, but much lower than in the UK (14%) and US (17%) (see graph page 20).

But although pay disparity is lower in New Zealand than in some other countries and the data suggests economic inequality has plateaued, there remains ample evidence that those who are able to reap the largest rewards from a growing economy are able to entrench their economic advantage. In a 2015 paper, economist Geoff Bertram wrote that inequality in wealth flowed from inequality in incomes. The increase in after-tax incomes of top earners increased their capacity to save, a long-term advantage not available to those on low incomes.

The data on household incomes also conceals the fact that families are working harder to stand still. Council of Trade Unions economist Bill Rosenberg notes that in the 1980s, half of two-parent households earned two incomes; between 2007 and 2013, that increased to two-thirds. And Rosenberg cites Treasury research in 2014 showing 30% of households with dependants earned less than the then living wage of $18.40 an hour.

Living on a modest income

Auckland worker Antoinette* has little time for elaborate arguments about whether the data justifies public concern about the widening gap between the country’s top executives and those at the bottom. She has more than enough to do already, working 40 hours a week, raising her and her partner’s two daughters, and trying to make ends meet on the couple’s two modest full-time wages.

Antoinette works at one of Briscoe Group’s Rebel Sports stores in Auckland. She is 31, has been with the company for 13 years and earns $19.35 an hour.

Her boss, Rod Duke, earns $1.04 million a year as Briscoe managing director. He earns in two weeks what it takes Antoinette a whole year to earn – and that’s without taking into account Duke’s estimated $600 million in wealth as 78% owner of the successful retailer.

Antoinette’s partner, a security guard, works full time on the minimum wage ($15.75 an hour). After they pay the weekly rent of $550 and meet other fixed expenses, the couple have about $100 in cash left for food and the costs associated with raising their two girls.

The stress of living on their modest income has been compounded by their precarious existence as tenants – they’ve had to move house three times in the past year, each time because the place they were renting was sold by the landlord. Aside from the significant disruption, each time they moved they had to come up with about $600 in letting fees.

Antoinette is an advocate for a collective pay agreement at Briscoe, but after seven years of attempted negotiations, no deal has been done. She says she is angry – about her pay rate and the failure to reach a deal with the company. She says when the store makes budget, the managers get a “big bonus”, but her bonus amounts to just $200 for the year.

“The big people get all the benefit, and the little people on the shop floor don’t. That’s just how it works.”

* The two workers interviewed requested anonymity because of concern that speaking publicly may cause difficulties with their employers.

State bosses rolling in it

Big pay rises for chief executives have not been limited to the private sector. State sector chief executives have also enjoyed hefty increases in remuneration.

The salary paid to the boss of the Ministry of Education, for instance, increased 56% between 2004/05 and 2015/16, from a band of $410,000-419,999 to $640,000-649,999. By comparison, the top base pay rate for teachers has increased 25% from $59,537 to $74,460 over the same period.

At the Ministry of Health, the chief executive’s pay has gone up 28% in the same period, from a band of $390,000-399,999 to $500,000-509,999.

The head of the Treasury was paid 52% more in 2015/16 than in 2004/05, increasing from $420,000-429,999 to $640,000-649,999.

Other increases include:

  • Inland Revenue chief executive: from a band of $420,000-429,999 in 2004/05 to $610,000-619,999 in 2015/16 (up 45%);
  • Internal Affairs – from $320,000-329,999 to $610,000-619,999 (up 90%);
  • Ministry of Justice – from $390,000-399,999 to $540,000-549,999 (up 38%).

Hamish Macdonald.

Stock exchange: Show us the money

The New Zealand Stock Exchange (NZX) is heightening its expectations for disclosure of executive and director pay for publicly listed companies. As part of a major overhaul of its corporate governance code of best practice, it proposes that companies have a remuneration policy showing the proportion of executive pay made up of cash, short-term and long-term performance bonuses and what performance criteria need to be achieved for those payments to be made.

For chief executive pay, companies will be expected to show actual amounts paid, broken down into base salary and short- and long-term bonuses. The amounts paid to each director will also need to be disclosed.

NZX head of policy Hamish Macdonald says the goal of the overhaul is to move New Zealand’s disclosure requirements closer to overseas stock exchanges, “without lurching too far” to prescriptive Australian-style requirements, which include a shareholder vote on remuneration reports – if more than 25% of shareholders vote against the remuneration report in two consecutive annual meetings, there can be a vote for the re-election of the board.

The NZX rules also stop short of requiring companies to disclose the ratio of chief executive pay and wages paid to the company workforce, as is being explored in the UK corporate governance review.

This article was first published in the April 29, 2017 issue of the New Zealand Listener.

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