Salary sacrifice

The job of chairman of a large company probably seems glamorous. The rewards include access to other powerful people, involvement in big deal corporate strategies, probably some international travel, and pay levels that are high compared to average wages – and all of this for part-time work.

The balancing factors include no doubt considerable time pressure. A chairman is never off-duty if the press or an investor wants to take up an issue, and regulators sometimes criticise them and the company or even take legal action if something goes awry. There is no doubt that these are not “average” people who should be earning an average wage; the role of chairman almost always requires proven corporate ability, demonstrated success, and maintenance of contacts built up in a lengthy business career. So are non-executive chairmen paid fairly for the roles? 

Mercer decided to take a look at comparisons between chair and chief executive pay, - including whether chair pay varies with company size - and at the total cost of board fees as part of a company’s total spend. We found that while board fees are increasing at a faster rate than the average wage, it appears that chair and board pay is lagging behind CEO pay despite the fact that the experience and skill of a chair must be commensurate with a CEO.

Executive pay vs non-executive director pay

Some people who are involved in corporate management think that pay for chairmen and non-executive directors (NEDs) is not high enough given the reputational risks they face, the skill requirements and extended demands on their available time. It is widely agreed that the chairman should have as widely-experienced a background as a CEO to fulfil the role of guidance and advice. Even though the daily pressures and challenges are different, the pay per hour should have some relationship.

To understand the correlation between chairman and CEO pay, we took Australia’s top 100 public companies and checked the ratio of the fees for the chairman to the fixed salary package of the CEO. We repeated the analysis for two years, separated by three years. Then we took into consideration the expected workload of a chair: the role of chairman in a large company is generally regarded as being about one-third (or even up to one-half) of a full-time workload.  The chair also has less direct pressure and in some ways less specific performance responsibility than the CEO, although corporate law is quite rigorous and threatening about the liabilities and responsibilities of directors including the chair. Fortunately in Australia we have relatively few cases where regulators find it necessary to take action against directors.

The figures show that a chairman is paid less than half “fixed” pay for this workload than the CEOs or the top executives in these companies, and does not get incentive payments which could more than double the pay for those full-time executives. What this shows is that the CEO is paid a salary, on average, five times that of the chair. In other words, the chair receives 20 per cent of the fixed pay received by the CEO.

The board chair is probably spending 30 per cent to 40 per cent of a full-time workload on the role, based on estimates and observations - an average of 35 per cent. But they are only getting 20 per cent of the pay. This comparison is much lower when the CEO’s incentive pay is taken into account. So will directors fees increase over time to catch up to CEO pay levels? Other analysis conducted by Mercer shows that conversely, CEO pay is increasing faster than the board pay. One could mount an argument that corporate Australia is keeping the fees for chairmen too low.

Size does matter

We examined the correlation between the size of the company, measured by market capitalisation, and the fee paid to the chair to see what bearing this had on the level of pay (see graph). This graph shows the fees for board members of Australia’s Top 300 companies, increasing according to size (MV). It shows the median fee within each group, for the chairman and the ordinary NED.

The upward trend is quite clear, and the relativity or gap between NED and chair is significant. It is larger for larger companies. Also visible is the kick-up in fees for chairmen of the biggest companies (in the Top 50 group). This represents a premium payable for the greater global challenges of these companies.

The correlation analysis findings shown in the graph are based on the 2006 pay data for consistency purposes, as not all company data for 2007 was available at time of going to print. There is a clear connection between pay and company size, and most people expect to see this relationship. Of course market capitalisation is not the only indicator of the “complexity” of a job, and companies with greater overseas exposure would probably be expected to pay more than those which are large but focussed mainly on Australia.

Chairman’s pay formula

An additional way to analyse “size vs pay” is to use correlation analysis, which shows not just the trend, but the strength of the connection and a formula for the average pay at each size level. Our analysis showed a strong connection between pay and size, and a formula connecting the two variables. We tested this analysis a few ways, and it comes out consistently. This is the nearest you could get to a “formula” for setting pay for the chairman, based on market data and the statistical assumptions.

Total board fees

The total pool of dollars available to the board of a listed company for board fees is controlled by shareholders under the ASX listing rules. This is done to give shareholders an opportunity to influence and control the total cost of the board and the fees paid to the board members. Of course the motion to increase the pool generally comes from the board, so the shareholders are tending to act as a “review” of the decision, rather than  an initiator. Given that the pool of fees for the largest companies is from about $2m upwards, with only a few above $3m, it can be argued that the pool of fees is very small within the total cost structure of a company. You can also argue that the influence of shareholders tends to be more of a test of reasonableness and restraint. Maybe there should be instances where shareholders insist the board have a bigger pool available, in order to recruit the skills needed to deal with difficult times.

The median cost of the board is approx. 0.3 per cent of the profit for those 23 companies we analysed, and a smaller portion of other parameters  such as revenue or expenditure.  So the amount of pay of the board members is not financially significant in terms of the results of the organisation, even though it is regarded as a big issue by shareholders. However, board fees are rising faster than average wages, with increases of the order of 10 per cent per annum observed in the large companies. Sometimes the fees are not adjusted every year, and can cover two or three years. 

Having said that, overall it appears that fees for board members in large companies in Australia seem to be set in a competitive and dynamic labour market, and to provide good value for shareholders. The broad and sustained success of large Australian companies over the last five to 10 years suggests that the system for board and executive pay is part of an effective overall governance system. It may even be a positive contributor to the effectiveness of Australian companies. Australian chairmen seem to be creating wealth for their shareholders, and while they are earning some good pay for themselves in doing so, there are arguments that they are not really fairly remunerated. There is a risk that if the fees for board members and chairmen are capped too low we will risk reducing the talent pool for chairmen and non-executive directors in the foreseeable future.

As many current chairmen will concur and as the pay analysis shows, the financials have made it more tempting for CEOs to remain longer in their current roles or seek a CEO position elsewhere rather than move into a director’s portfolio. As a consequence, the pool of high quality candidates for NED and chairman roles in Australia is shrinking, and this will pose a significant risk to many of our publicly listed companies.

The pay structures of CEO’s and non-executive directors will need to be more closely aligned if we are to ensure the supply of directors can meet the demands of boards well into the future. But further education and engagement with shareholders will be required if boards are to secure a larger pool of fees to recruit the required talent to deal with the difficult times ahead.

Paul Riggs is a principal at Mercer Human Resource Consulting.