CEO pay is obscene but it's not the real issue

Yes the pay is obscene, but don't be distracted.

According to some estimates, US chief executives earn somewhere around 400 times the salary of the average worker in their companies. Four hundred times.

Few people would begrudge successful business people a little extra for the hard work and effort to get to - and stay at - the top. But that's more than just a little extra.

By comparison, the average Japanese chief executive earns around 50 times the average worker's pay, and the British 180 times. The ABC recently reported that among an Australian sample, chief executives received between 15 times and 100 times the average employee's pay packet.

It's a brave person who argues that any chief executive could objectively be worth up to 400 times what they pay their employees, no matter who that manager is.

And that's the problem - these things aren't objective. There's a very nice little self-reinforcing process that sees compensation consultants paid for giving advice to boards as to how much executives should be paid.

They do it by comparing the salaries of similar chief executives - whose pay was set by comparing them to similar chief executives ??? and so on.

It's the corporate version of keeping up with the Joneses - and shareholders are footing the bill.

Those numbers blow out even further, though, when you add short and long-term bonuses to the mix - which often dwarf a corporate boss' regular salary.

It's obscene, and should be changed. But, it's a sideshow, and here's why.

Yes, those at the top of the tree are paid a comparative fortune. And they often receive bonuses on top of that for cutting costs, including laying off staff.

But on a per share basis, those salaries are almost always close to a rounding error. That is, when amortised across the company's owners, even if pay was cut in half, shareholder returns wouldn't improve by any noticeable amount.

For example, CBA's outgoing boss, Ian Narev???, earned $5.5 million in the last financial year, down from $12.3 million in 2016.

That's a fraction of 1 percent of the company's $130 billion market capitalisation. And it's still a fraction of 1 percent, compared with the company's recently announced $10 billion profit.

Narev could have worked for $1, and shareholder returns wouldn't have improved perceptibly.

The problem, then, isn't that being paid too much impacts shareholder returns in the year the salary is paid. Ideological concerns aside, paying Narev (or most other ASX-listed company chief executives) less won't move the dial.

Instead, we should look to incentives. While Narev's $5.5 million doesn't mean anything financially to CBA shareholders, you can bet the fall from $12.3 million the year before was keenly felt by Narev. The reverse, for chief executives who did receive big bonuses, is almost certainly true.

There are a couple of nice aphorisms that, together, highlight the real problem: "Whose bread I eat, his song I sing" and "What gets measured, gets done" summarise the challenge neatly.

When you offer a corporate executive a lotto-winning-equivalent amount of money for achieving certain objectives, you'd better believe it focuses the mind, and drives certain behaviour (and if any chief executive tells you it doesn't, then suggest they give the bonus back. I'll bet they don't).

But bonuses are paid on notoriously short-term results - usually a single year's performance, sometimes three. And the metrics used? Company profits and share price gains.

So let me give you an analogy. If I'm being remunerated on managing your car's financial performance over the short term, it's easy to manage. I won't bother getting it serviced. I won't replace the tyres, even though the tread is getting low, and I'll put cheap fuel in it. Then, I'll show you how much money I "saved" on car maintenance and you'll give me a bonus.

Then, I'll sell it for you, being a little economical with the truth when talking to the buyer, and showing him how little it costs to run. Impressed, he'll pay me more, sending the car's price up. Bingo, a higher sale price, and another bonus for me.

Of course, the costs aren't sustainable, and the car was overpriced ??? but I don't care: I've received my bonus and I'm off to greener pastures. The car is someone else's problem now.

Chief executives are objectively paid too much money. There is a real issue of social equality at play.

But even when it comes to a purely financial transaction, the system is broken. The simplest fix - though chief executives the world over would complain bitterly - is to pay bonuses to chief executives based on the company results over the following five years.

That way, they're incentivised to set a company up for long-term success - not just put lipstick on a pig.

???Scott Phillips is the Motley Fool's director of research.

The story CEO pay is obscene but it's not the real issue first appeared on The Sydney Morning Herald.

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