Growth at any cost: CEOs incentivised to take excessive risk
- Australia’s largest financial institutions are facing criticism on how their executives are remunerated.
- Unlike regular employees, the CEOs of Australia’s largest banks receive the majority of their pay through incentives, such as cash bonuses, stock options and shares.
- Research by Monash Business School found adverse firm events are 42 per cent more likely to occur when the majority of CEO pay consists of stock options and shares.
In one of the first studies to directly link CEO incentive pay to adverse firm events, new Monash University research finds adverse firm events are 42 per cent more likely to occur when the majority of CEO pay consists of stock options and shares.
This study is released as leaders of Australia’s largest financial institutions continue to face criticism from stakeholders for their lucrative pay packets, driven primarily by risk-based incentives and bonuses.
A research team from Monash Business School identified a direct link between the Australian Securities and Investments Commission (ASIC) investigating or penalising a company and the way CEOs are paid.
Using a sample of 23 CEOs from 12 of Australia’s largest financial institutions, the study identified 75 adverse events which occurred in the two-year period after the CEOs departed from their roles.
The mean annual total remuneration package for the CEOs in the study was $8 million, nearly double the mean CEO pay in other ASX100 companies.
John Mitchelhill, lead author and Honours student in the Monash Business School’s Department of Management, suggests Boards of Directors should look at enforcing minimum shareholding requirements as it would temper CEO risk, knowing there is a greater level of wealth at stake.
He says this could potentially reduce the number of adverse events that occur during and after CEOs leave their company.
“While no adverse events occurred for the majority of CEOs in the study, however, when one event occurred, it was likely that other ‘negative’ events followed,” John said.
For example, in the financial year of 2017, Ian Narev, the ex-CEO of Commonwealth Bank Australia (CBA), received total statutory remuneration of $5.5 million, a lot of which was attributed to cash bonuses, stock options and share incentives.
In the two-year period following Mr Narev’s departure amid fraud and money-laundering concerns, CBA, amongst other things, were:
- Forced to repay $119 million (including interest) for fees for no service.
- Required to pay $15 million for rigging the Bank Bill Swap Rate (BBSW).
- Made to refund $10 million after selling more than 65,000 customers unsuitable insurances.
John’s research, which was supervised by Professor Mathew Hayward and Associate Professor Pitosh Heyden, also found that incentive pay was up to 90 per cent higher than the amount received as a fixed salary for some CEOs.
“The research challenges Boards of Directors of Australia’s largest financial institutions to drop their ‘mutual back scratching’ and place greater weighting on non-financial performance metrics,” John said.
Boards of Directors for ASX listed companies traditionally determine CEO pay through a ‘Remuneration Committee’.
John says boards need to show leadership. In doing so, they can place greater focus on non-financial metrics, such as corporate social responsibility, quality of service and governance, instead of just improving company financial performance.
“However, evidence suggests there is a link between highly paid Boards of Directors and highly paid CEOs. This can result in Directors who may not want to bring attention to a firm culture of excessively paying executives due to the potential for their own excessive pay to also be critiqued,” he said.
“In addition, Boards are often stacked with friends of friends and Directors who sit on multiple other ASX Boards, resulting in circumstances where it’s not in a Director’s best interests to criticise friends and colleagues due to a potential impact to their future job prospects.”