Adherence to the spirit of corporate governance : the ethics of executive remuneration

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(1)Adherence to the spirit of corporate governance: The ethics of executive remuneration by Elke Gevers Minor dissertation SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE Magister Commercii in Industrial Psychology in the Faculty of Management: Department of Industrial Psychology and People Management at the University of Johannesburg Supervisor: Prof L. J. van Vuuren Co-supervisor: Dr L. Fourie Dr M. Bussin November 2012.

(2) FACULTY OF MANAGEMENT DECLARATION OF THE CORRECTNESS OF THE FINAL SUBMISSION OF ELECTRONIC COPY OF MINOR DISSERATION/DISSERTATION/THESIS AFTER EXAMINATION DECLARATION BY STUDENT (To be sent to the library and examiners) STUDENT NUMBER. ID NUMBER. I, (Mr / Ms) Elke Karin Gevers hereby declare that the digital/electronic format of the minor dissertation/dissertation/thesis submitted for the degree: MCom in Industrial Psychology is a true reflection of the examined minor dissertation/dissertation/ thesis and incorporates any corrections that may have been requested by the examiners. The printed and electronic copies correspond in all respects. I am aware that the making of a false statement could render me liable for criminal prosecution. POSTAL ADDRESS:. CONTACT NUMBERS: HOME: WORK: CELL:. POSTAL CODE:. EMAIL:. SIGNATURE OF STUDENT. DATE. FOR OFFICE USE ONLY Received on …………………………… at …………………………… ______________________________________ SENIOR FACULTY OFFICER. ii.

(3) AFFIDAVIT: MASTER’S AND DOCTORAL STUDENTS TO WHOM IT MAY CONCERN This serves to confirm that I: (Full Name(s) and Surname. Elke Karin Gevers. ID Number: Student number:. enrolled for the. Qualification:. MCom (Industrial Psychology). Faculty:. Faculty of Management. Herewith declare that my academic work adheres to the Plagiarism Policy of the University of Johannesburg with which I am familiar. I declare that the work presented in my minor dissertation / dissertation / thesis is authentic and original unless clearly indicated otherwise and in such instances full reference to the source is acknowledged. I do not pretend to receive any credit for such acknowledged quotations, and that there is no copyright infringement in my work. I declare that no unethical research practices were used or material gained through dishonesty. I understand that plagiarism is a serious offence and that should I contravene the Plagiarism Policy notwithstanding signing this affidavit, I may be found guilty of a serious criminal offence (perjury) that would amongst other consequences compel the UJ to inform all other tertiary institutions of the offence and to issue a corresponding certificate of reprehensible academic conduct to whomever requests such a certificate from the institution. Signed at _____________________on this ______________day of _______________ 20___. Signature__________________________________ Print name_________________________. STAMP COMMISSIONER OF OATHS Affidavit certified by a Commissioner of Oaths This affidavit conforms with the requirements of the JUSTICES OF THE PEACE AND COMMISSIONERS OF OATHS ACT 16 OF 1963 and the applicable Regulations published in the GG GNR 1258 of 21 July 1972; GN 903 of 10 July 1998; GN 109 of 2 February 2001 as amended.. iii.

(4) ABSTRACT. With the implementation of King III in 2010 and the promulgation of the new Companies Act in 2011, the corporate governance landscape in South Africa was irrevocably changed. Simultaneously, there was an increase in the protestations against the perceived excesses of executive1 remuneration packages. The question posed in this research study was what does adherence to the spirit of corporate governance with regard to executive remuneration entail? The literature study explores the perceived separation between ownership and control, as well as attempts at controlling this separation via structured executive remuneration packages. It further provides an overview of the relative efficacy of voluntary codes and compulsory codes. Various methods of determining executive remuneration are investigated and the possible shortcomings of each are identified. Sixteen semi-structured, in-depth interviews, equally divided amongst four interest groups in the field of executive remuneration, were conducted. A content analysis of the qualitative data that emerged from the interviews resulted in 39 first-order themes that were then iterated to 11 second-order themes. These second-order themes were categorised into two sets, namely five that are indicative of behaviour in support of adherence to the spirit of corporate governance with regard to executive remuneration, and six that are indicative of behaviour that undermines the spirit of corporate governance in this regard. The five themes indicative of behaviour in support of adherence to the spirit of corporate governance were: problem recognition, sustainable development, embracing governance, remuneration management competence, and ethical intent. The six themes found to indicate behaviour that undermines adherence to the spirit of corporate governance with regard to executive remuneration were: shareholder appeasement,. 1. The term ‘executive’ is used for ease of reading, but refers to all members of the board (including nonexecutive directors) as well as senior management.. iv.

(5) misrepresentation, elitism, justification, arrogance, and intentional amorality. It emanated from the findings that greater social debate should be stimulated on how ethics can be brought into the domain of executive remuneration. A potentially important facilitator of such debate could be tertiary education institutions responsible for management education integrating the ethics of executive remuneration in curricula. It is further recommended boards, who are tasked with the governance of their organisations, be made aware of the behavioural manifestations that support or undermine adherence to the spirit of governance as it relates to executive remuneration. Remuneration consultants could also benefit from these findings, and could assist organisations to design fair and responsible systems of remuneration for executives and senior employees. Keywords: business, ethics, remuneration, executive pay, compensation, corporate governance.. v.

(6) Contents List of Tables ..................................................................................................................................viii List of Figures ................................................................................................................................... ix. CHAPTER 1: INTRODUCTION........................................................................................... 1 1.1. Background ........................................................................................................................... 1. 1.2. Research design ..................................................................................................................... 5. 1.3. Chapter integration............................................................................................................... 6. CHAPTER 2: THEORETICAL PERSPECTIVES ON CORPORATE GOVERNANCE AND EXECUTIVE REMUNERATION ............................................................................... 7 2.1. Introduction ........................................................................................................................... 7. 2.2. Towards an understanding of corporate governance ........................................................ 7. 2.3. Governance in South Africa ................................................................................................. 9. 2.3.1. The spirit of corporate governance. .............................................................................. 11. 2.3.2. The King III report ........................................................................................................ 14. 2.3.3. King III and executive remuneration. ........................................................................... 15. 2.4. Executive remuneration ..................................................................................................... 20. 2.4.1. Executive remuneration: reason for concern? ............................................................... 22. 2.4.2. The principal-agent relationship and executive remuneration. ..................................... 24. 2.4.3. Determinants of executive remuneration. ..................................................................... 25. 2.4.4. The influence of the board on executive remuneration. ................................................ 37. 2.5. Chapter integration............................................................................................................. 40. CHAPTER 3: METHOD ...................................................................................................... 41 3.1. Introduction ......................................................................................................................... 41. 3.2. Research Method ................................................................................................................ 41. 3.2.1. Research design............................................................................................................. 41. 3.2.2. Research paradigm. ....................................................................................................... 43. 3.2.3. Methodology: qualitative research. ............................................................................... 45. 3.2.4. Research strategy. ......................................................................................................... 45. 3.3. Ensuring quality research .................................................................................................. 53. 3.3.1. Credibility. .................................................................................................................... 54. 3.3.2. Transferability. .............................................................................................................. 54. 3.3.3. Dependability. ............................................................................................................... 54. 3.3.4. Confirmability. .............................................................................................................. 55. 3.4. Ethical considerations ......................................................................................................... 55. 3.5. Chapter integration............................................................................................................. 56. vi.

(7) CHAPTER 4: RESULTS ...................................................................................................... 57 4.1. Introduction ......................................................................................................................... 57. 4.2. Results .................................................................................................................................. 57. 4.3. Chapter integration............................................................................................................. 76. CHAPTER 5: DISCUSSION, FINDINGS, AND RECOMMENDATIONS .................... 77 5.1. Introduction ......................................................................................................................... 77. 5.2. Discussion............................................................................................................................. 77. 5.2.1. Behaviours that undermine adherence to the spirit of corporate governance. .............. 78. 5.2.2. Behaviours that foster adherence to the spirit of corporate governance. ...................... 84. 5.3. Conclusion and recommendations ..................................................................................... 90. 5.3.1. Overview. ...................................................................................................................... 90. 5.3.2. Main findings. ............................................................................................................... 91. 5.3.3. Recommendations. ........................................................................................................ 92. 5.3.4. Recommendations for future research. ......................................................................... 94. 5.3.5. Limitations of the study. ............................................................................................... 94. 5.3.6. Final thoughts................................................................................................................ 95. References ............................................................................................................................... 96. vii.

(8) List of Tables. Page. 1. Differences between legal and ethical compliance approaches. 12. 2. King III principles and recommendations relevant to executive remuneration. 16. 3. King III principles and recommendations relevant to boards. 18. 4. King III principles and recommendations relevant to board decision-making. 19. 5. Components of executive remuneration. 21. 6. Interview schedule. 47. 7. Profiles of participants. 50. 8. First-order themes. 58. 9. Second-order themes: Behaviours that undermine adherence to the spirit of. 73. corporate governance with regard to executive remuneration 10 Second-order themes: Behaviours that foster adherence to the spirit of corporate governance with regard to executive remuneration. viii. 75.

(9) List of Figures. Page. 1 Research design. 42. 2 Coding from texts. 52. ix.

(10) CHAPTER 1: INTRODUCTION The purpose of this chapter is to sketch the background to the research problem, including the aims of the research, as well as the expected contribution of the study. It further introduces the main constructs of the research, namely governance and executive remuneration. The chapter concludes with the research design.. 1.1. Background “But finance, free trade and competition are only means, not ends. From the moment we accepted the idea that the market was always right and that no other opposing factors need be taken into account, globalisation skidded out of control.” - President Nicolas Sarkozy at the opening of the 40th World Economic Forum (2010, p.1) (Sarkozy, 2010). This statement by the then-president of France appears to be in contrast to that of Adam Smith, the man viewed as the father of capitalism, who stated: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their selflove” (Joyce, 2001, p. 3). This "regard for the own interest" became evident in a review of newspaper headlines. The Mail & Guardian2 reported on November 12, 2007, that Tiger Brands had been ordered to pay a R98.7 million penalty by the Competition Commission after admitting to having participated in bread and milling cartels and subsequent pricefixing. On November 09, 2009, an article titled “Eskom saga a ‘complete disaster’ " was published. On February 14, 2010, the Sunday Times featured an article on Alan Knott-Craig (former CEO of Vodacom SA) with the heading “R24m for doing nothing,” alleging that “The latest controversy surrounding Knott-Craig – one of the country’s most respected 2. Newspaper articles were relied upon to illustrate the topicality of this research; also, as this information is in the public domain and shapes public perception of executive remuneration, it is viewed as relevant to this study.. 1.

(11) corporate leaders – follows a litany of embarrassing and explosive allegations in a closely guarded KPMG forensic report.” An article dated April 16, 2010, reported with conviction: “Alliance investors defrauded,” “it’s clear that money was misappropriated and that shareholders were effectively defrauded...” The then-president of France may have been justified in stating that, in contrast to the statement of Adam Smith, the market alone will not prevent abuse. If the market alone is insufficient in preventing abuse, additional measures to govern the market are required or, as the French president referred to it, “an opposing force.” One such opposing force in the corporate landscape may be that of corporate governance. It should, however, not be inferred that by espousing corporate governance principles and recommendations, an effective opposing force to the market has been established. Corporate governance is only as effective as those who drive and own it within an organisation. This interpretation is aligned to that provided in the Third King Report on Governance for South Africa 2009 (hereafter referred to as King III) that “Good corporate governance is essentially about effective, responsible leadership” (IoD, 2009, p. 20). In other words, corporate governance is the responsibility of the board, and accentuates the critical role played by the directors of organisations. These leaders, together with their actions, are the ‘face’ of their organisations. Toor and Ofori (2009) believe that the impact of either ethical or unethical behaviour in organisations is increasingly evident in present-day organisations. According to these authors, the growing complexity of organisations, unprecedented growth in the information technology arena that escalated the amount and speed of information flow, and greater demands for performance from leaders have increased the probability of conscious – and sometimes unconscious – ethical mistakes in decisions, actions, and behaviours. There does, 2.

(12) however, appear to be another dimension to the continuum of ethical and unethical behaviour. Carroll and Buchholtz (2006) refer to it as "amoral management," and distinguish between intentional and unintentional amoral management. They describe intentional amoral management as actions where ethical considerations are not factored into decisions, actions, and behaviours, as it is believed that business activity and moral judgement are two mutually exclusive aspects. “These managers tend to be neither moral nor immoral. They simply think that different rules apply in business than in other realms of life” (Carroll & Buchholtz, 2006, p. 189). Unintentionally amoral managers are simply relaxed and careless about, or inattentive to, the fact that their decisions and actions may have deleterious effects on others. These managers lack ethical perception and awareness; that is, they go about their organisational lives in an indifferent fashion, not thinking that what they are doing has an ethical dimension or consideration (Carroll & Buchholtz, 2006, p. 189). One area that appears to have an ethical dimension requiring (ethical) leadership is that of executive remuneration. Executive remuneration is an area of ethical concern that should be addressed by corporate governance. Matsumara and Shin (2005, p.108) believe that “one tends to give more attention to corporate governance than executive remuneration; yet executive remuneration is a function of corporate governance.” Tiger Brands, which, as mentioned earlier, while embroiled in a price-fixing scandal, paid the then chief executive R418 686 in recognition of 25 years of service, serves as case in point. In the same year, he was also compensated R39 million, which included R28 million in stock options (Leader.co.za, 2008, p. 3). Articles covering executive remuneration appear almost on a daily basis, for example: the Sunday Times, May 2, 2010, reported that “Envy, anger as banks lift veil on bosses’ pay.” It was reported that “ ‘ex gratia’ payments of R7.5 million and R24.5 million respectively were paid to two retiring board members of leading banks.” It appears that the issue of 3.

(13) executive remuneration is not only a corporate governance issue, but also one that concerns the larger population due to the perceived disparity between the earnings of executives and that of the average employee. It is against this background that one could argue that, without a renewed focus on the ethics of executives and ethics within organisations, the issues and concerns around executive remuneration will not be resolved. Already in 1990, Lawler (1990, p. 3) stated that “many organisation are more concerned with doing the wrong things right than with searching for the right pay practices.” A renewed emphasis on the ethics of those tasked with the direction and control of an organisation, and the ethics of establishing executive remuneration strategies, requires mindful interpretation and application of the spirit of corporate governance. In other words all deliberations, decisions, and actions should willingly and freely be premised on the four ethical values of corporate governance (discussed below) (IoD, 2009). Adherence to the spirit of corporate governance can be expressed in terms of behaviours, which are also evident in executive remuneration practices. King III recommends certain principles and practices with regard to corporate governance and executive remuneration (IoD, 2009, p. 17), but the question remains: How are these applied within organisations with due consideration to the four ethical values of corporate governance, at the same time going above and beyond these to adhere to the underlying spirit of corporate governance? This study therefore aims to answer the following question: What does adherence to the spirit of corporate governance with regard to executive remuneration entail? The study aimed to achieve the following objectives: To determine behaviours that foster adherence to the spirit of corporate governance with regard to executive remuneration; and 4.

(14) To determine behaviours that undermine adherence to the spirit of corporate governance with regard to executive remuneration. A thorough literature review (see Chapter 2) provides the theoretical framework within which these questions are posed.. The constructs of corporate governance and. executive remuneration are explored in some detail. The research design utilised to address the research problem is described in the following section.. 1.2. Research design. To answer the posed research question, i.e. what adherence to the spirit of corporate governance in executive remuneration would entail, it was decided to utilise a qualitative research methodology. A qualitative rather than a quantitative research methodology was chosen, as the spirit of corporate governance does not readily lend itself to quantification, but rather to exploration, interpretation, and understanding. The researcher compiled interview questions, which were asked during semi-structured, in-depth interviews to allow the researcher to understand how the participants experience the phenomenon of corporate governance and executive remuneration. Since the research question is fairly specific, it was important that participants had knowledge and expertise on the subject matter of this research. The research participants were therefore selected using purposive and snowball sampling techniques. The gathered data were subjected to systematic content analysis, and the findings were noted. The study aims to make specific contributions: Firstly, to make both boards and remuneration consultants aware of the influence of certain behaviours on adherence to the spirit of corporate governance in executive remuneration.. This awareness should then. encourage the development of strategies to address ethical issues pertaining to executive 5.

(15) remuneration, and also stimulate further research in the challenging area of executive remuneration.. 1.3. Chapter integration. This chapter provided a brief outline of the research problem and the research objectives.. The constructs of executive remuneration and corporate governance were. introduced, while also providing a brief overview of the research design and expected contributions of the study. In the next chapter, the literature review is presented, and the constructs of executive remuneration and corporate governance are explored in greater detail.. 6.

(16) CHAPTER 2: THEORETICAL PERSPECTIVES ON CORPORATE GOVERNANCE AND EXECUTIVE REMUNERATION 2.1. Introduction. The previous chapter provided a brief background to the research problem. In this chapter, the constructs of executive remuneration and corporate governance are explored in greater detail by means of an analysis of relevant literature. The chapter commences with an outline of governance in general, and then progresses to an overview of corporate governance in South Africa, the spirit of corporate governance, and the provisions of King III. Thereafter, overviews of the construct of executive remuneration as well as possible reasons for concern are discussed, as are possible determinants of executive remuneration.. In. conclusion, the influence of the board of directors on the setting of executive remuneration is investigated.. 2.2. Towards an understanding of corporate governance. Governance is derived from the French word gouvernance, which refers to the exercising of authority and control (Agumba, 2008, p. 2). The Oxford Advanced Learner’s Dictionary (2010, p. 649) defines governance as "the activity of governing a country or controlling a company or an organisation; the way in which a country is governed or a company or institution is controlled." While the word ‘governance’ appears to have a very legalistic and autocratic tone, it is important to note that there are two forms of this control: one which is regulated or legislated, and one that is principle-based. The latter form of. 7.

(17) control is thus not enforced by law, and is therefore voluntary. Voluntary governance is the prevailing form of governance in South Africa and also the focus of this research report. A review of the literature revealed various descriptions of the concept corporate governance. Rossouw and Van Vuuren (2010, p.190) refer to corporate governance as “the system by which companies are directed and controlled,” as originally described in the Cadbury Report on Corporate Governance in the UK. King III states that good corporate governance is essentially about effective, responsible leadership (IoD, 2009, p.20). Davis (2005, p. 143) describes corporate governance as the structures, processes, and institutions within and around organisations that allocate power and resource control to participants. Daily and Dalton (2003, p. 371) define corporate governance as the determination of the broad uses to which organisational resources will be deployed, and the resolution of conflict among the myriad of stakeholders in organisations. Aguilera and Jackson (2003, p.450) conceptualise corporate governance as the relationships among stakeholders in the process of decision-making, control over organisational resources, and, ultimately, the outcome of interactions among multiple stakeholders. One element that is, however, not clearly illustrated in the definitions above is that, while there is a focus on the equitable distribution of resources, there should be as much focus on all actions taken by the organisation and its executives to either prevent or minimise harm to employees, and also on achieving sustainable economic, social, and environmental outcomes (IoD, 2009, p. 10). In summarising the numerous definitions regarding corporate governance, one could describe corporate governance as the system and processes that enable and guide the equal distribution of resources among various stakeholders in the most equitable and justifiable way, while at all times aiming to achieve sustainable economic, social, and environmental objectives and preventing or minimising harm to all stakeholders.. 8.

(18) There appears to be a prevailing discernment that this distribution of resources among stakeholders and the prevention of harm have not been applied equitably or justifiably, and that the systems and processes are failing the very people that allow organisations to exist within their society. As referred to earlier, one manner of minimising harm or preventing abuse is through good corporate governance. To follow is a description of governance in South Africa.. 2.3. Governance in South Africa. Corporate governance is a concern worldwide. In the United States of America, after numerous accounting scandals and incidents of fraud, most notably that of Enron and WorldCom, the Public Company Accounting Reform and Investor Protection Act of 2002, short-titled the Sarbanes-Oxley Act, was signed into law on July 30th 2002, by the thenpresident, George W. Bush (Rezzy, 2007, p. 104). This made corporate governance a matter of law. In 2008, the Basel Committee, established at the end of 1974, released Basel III. According to the Bank for International Settlements, “Basel III is a comprehensive set of reform measures to strengthen the regulation, supervision and risk management of the banking sector” (Basel Committee on Banking Supervision, 2012). Basel III has a threepillar approach to capital adequacy in banks, involving (1) minimum capital requirements, (2) supervisory review of internal bank assessments of capital relative to risk, and (3) increased public disclosure of risk and capital information, sufficient to provide meaningful market discipline (Saidenberg & Shuermann, 2003, p. 6). In contrast to the Sarbanes-Oxley Act, Basel III is not a matter of law, but rather a set of preventative measures.. 9.

(19) Corporate governance rose to prominence in South Africa largely due to economic, social, and political crises that imposed change on the corporate landscape. South Africa became a global player in the market after the collapse of Apartheid in 1994. Although this was a positive development, it also brought challenges, in that organisations could no longer be complacent about their business practices due to increased international scrutiny (Vaughn & Ryan, 2006). In response to this development and due to a desire to be competitive in the global market, the Institute of Directors in Southern Africa issued the first King Report on Corporate Governance (Vaugh & Ryan, 2006).. In 2002, the Second King Report on. Corporate Governance was published. According to the chairman of the King Committee, King III was necessitated by the new Companies Act no. 71 of 2008 and changes in international governance trends (IoD, 2009). A distinction, however, needs to be made between King III, which proposes a voluntary participation approach, and the new Companies Act (which came into effect on 01 May 2011), which is legislation and thus enforceable.. The Companies Act contains. provisions governing the manner in which directors do their jobs, and imposes severe financial sanctions on those directors who do not comply. King III distinguishes between legislation and corporate governance, with corporate governance aiming to establish and facilitate the establishment of structures and processes that enable directors to discharge their legal responsibilities (IoD, 2009). Various changes in the macro environment, such as innovation in technology and changes in the legal landscape necessitated a change in the corporate governance arena. Technological advances not only created a virtually borderless world for the flow of capital, but also brought with it the increased risk of detrimental public relations.. These. developments heightened the importance of sound corporate governance practices. Lawler (1990, p. 9) also ascribes the rapid change in the business environment to, amongst others, 10.

(20) global interdependencies and rapid advances in technology. Darcy (2010) believes that, in the current age of information, there are neither secrets nor places to hide, and that reputational risk in present-day organisations is as worrisome as strategic operating and financial risk. It is clear that corporate governance is of importance worldwide. However, the focus of this research study is on corporate governance as conceptualised by King III, in other words, corporate governance within the South African context. To follow is a discussion of the spirit of corporate governance as intended by King III. 2.3.1. The spirit of corporate governance.. Although corporate governance may appear to contain a legal element, the spirit of corporate governance does not imply mere compliance, but rather offers governance as an alternative approach to which organisations should aspire and engage in. Arjoon (2005, p. 345) posits that, Although a necessary component of corporate governance, legal compliance mechanisms have clearly proven to be inadequate: they lack the moral firepower to restore confidence and the ability to rebuild trust in the corporation. A mere legalistic approach to corporate governance also runs the risk of creating a focus on checklists and not on developing decision-making capacity and independent, ethical reasoning (Maharaj, 2008).. Darcy (2010) believes that when people act out of ethical. conviction, they act out of choice, which is not necessarily the case when acting out of compliance. “It [compliance] is an approach that fosters a blind adherence to the law, and punishment for non-adherence” (Arjoon, 2005, p. 347). Arjoon (2005) is further of the. 11.

(21) opinion that a legalistic approach emphasises primarily the strict and precise observance of law while tending to overlook the purpose for which the law exists. Corporate governance, therefore, is not the mere adherence to the law, but an understanding of the spirit of the law.. In other words, while there might be a legal. component to corporate governance, there is also a definitive ethical component. King III (IoD, 2009, p. 21) goes as far as to suggest that ethics is the foundation of, and reason for, corporate governance, and that corporate governance is, in essence, the practical expression of the organisation’s ethical standards.. The differences in these two approaches are. represented in Table 1. TABLE 1 Differences between legal and ethical compliance approaches to governance (from Arjoon, 2005, p. 348) Factors Ethos. Legal. Ethical. Regards ethics as a set of limits and. Defines ethics as a set of principles. something that has to be done.. to guide choices.. Geared toward preventing unlawful. Geared toward achieving. conduct.. responsible conduct.. Emphasizes rules and uses increased. Infusion of ethics into business. monitoring and penalties to enforce these. practices (leadership, core systems,. rules.. decision-making processes, etc.).. Behavioural. Rooted in deterrence theory (how to. Rooted in individual and communal. assumptions. prevent people from doing bad things by. value (both material and spiritual).. Objectives. Method. manipulating the costs of misconduct).. While there are countries within which the corporate governance spirit is characterised by a 'comply or else' approach, the approach in South Africa is typified by 'apply or explain.' To clarify the difference: the 'comply' approach is typically found in. 12.

(22) countries where governance was legislated, while the 'apply' approach is found in countries where governance regulations have not been legislated. The USA is one of the countries that have adopted the 'comply or else' approach. There are various reasons why the 'apply or explain' approach was adopted in South Africa. King III (IoD, 2009, p. 6) states that all organisations are different, and an approach of 'one size fits all' would therefore be folly. Another reason why the strict compliance approach was abandoned is that the cost of compliance is burdensome. This train of thought is shared by Eubanks (2008, p. 2) and Maharaj (2008), who point out that the Sarbanes-Oxley Act of 2002 is a drain on corporate America, and that the costs associated with complying with the Act are much greater than the possible benefits. Vakkur, McAfee, and Kipperman (2010) indicate growing evidence that rules-based systems are, in fact, more costly than flexible, principle-based systems. A further consideration is that a narrow focus on compliance by an organisation might be at the expense of the organisation. Too much time might be spent on ticking all the boxes, at the expense of directing and controlling the organisation. The debate of the compliance (legal) approach versus the ethical (King III) approach is possibly best summarised in Eubanks’s (2010, p. 2) words: “If ethical standards had been enforced, then there should have never been a problem with illegal reporting on financial statements. Knowing what is right and doing what is right are two very different ideas.” In summary then, corporate governance requires mindful application rather than mindless compliance; or, as summarised by Darcy: “... ethics, it’s not about perfection; it’s about progress. It’s about making better decisions and staying away from worse decisions, as we go through this journey called life” (2010, p. 204). To facilitate an understanding of the issues requiring consideration with regard to executive remuneration, a brief overview of the 13.

(23) ethical values that are recommended as the basis of all ethical decisions within organisations, as stated in King III, is provided hereunder. 2.3.2. The King III report. King III is relevant to all entities, regardless of size or nature of the organisation, and was implemented in South Africa on the 1st of March 2010. As an ethical foundation of corporate governance, King III requires that all deliberations, decisions, and actions of the board and executive management be based on the following four ethical values underpinning good corporate governance (IoD, 2009, p. 50): Responsibility: The state or position of having control or authority and being accountable for one’s actions and decisions. Accountability: Being responsible and able to justify and explain decisions and actions. Fairness:. Free from discrimination or dishonesty and in conformity with rules and standards.. Transparency: Easy to understand or recognise; obvious; candid; open; frank. Consequently, all decisions the board makes and strategies or policies that are drafted should be founded on the four ethical values of responsibility, accountability, fairness, and transparency. Of interest in the present study is the relationship between these ethical values and executive remuneration. It should be noted that King III does recommend practices and principles as a guide towards operationalising the abovementioned ethical values.. 14.

(24) 2.3.3. King III and executive remuneration.. The recommended practices and principles contained in King III that guide operationalising of the four ethical values and have relevance to executive remuneration are summarised in Table 2 for ease of reference. Table 2 is divided into sections according to the governance element that governs those principles and recommended practices. In the left column, the principle is given, paired on the right with the recommended practice. The numbering in the table is in accordance with the relevant section numbers as contained in King III.. 15.

(25) Table 2 King III principles and recommendations relevant to executive remuneration (From IoD, 2009, pp. 19-48). Principle(s). Governance Element: Boards and Directors (Board committees) Recommended Practice. 2.23. The board should delegate certain functions to wellstructured committees, but without abdicating its own responsibilities.. 2.23.6. Companies should establish risk, nomination, and remuneration committees. 2.23.9. Committees should be free to take independent outside professional advice at the cost of the company subject to an approved process being followed.. Governance Element: Remuneration of directors and senior executives Recommended Practice Principle(s) 2.25. Companies should remunerate directors and executives fairly and responsibly. IoD, 2009, p. 30. 2.25.1. Companies should adopt remuneration policies aligned with the strategy of the company and linked to individual performance. 2.25.2. The remuneration committee should assist the board in setting and administrating remuneration policies. 2.25.3. The remuneration policy should address base pay and bonuses, employee contracts, severance and retirement benefits, and sharebased and other long-term incentive schemes.. 2.26. Companies should disclose the remuneration of each individual director and certain senior executives.. 2.25.4. Non-executives fees should comprise a base fee as well as an attendance fee per meeting. The remuneration report, included in the integrated report, should include: 2.26.1. all benefits paid to directors; 2.26.2. the salaries of the three most highly-paid employees who are not directors; 2.26.3. the policy on base pay; 2.26.4. participation in share incentive schemes; 2.26.5. the use of benchmarks; 2.26.6 incentive schemes to encourage retention; 2.26.7. justification of salaries above the median; 2.26.8. material payments that are ex-gratia in nature; 2.26.9. policies regarding executive employment; and. 2.27. Shareholders should approve the company’s remuneration policy.. 2.26.10. the maximum expected potential dilutions as a result of incentive awards. 2.27.1. Shareholders should pass a non-binding advisory vote on the company’s yearly remuneration policy. 2.27.2. The board should determine the remuneration of executive directors in accordance with the remuneration policy put to shareholders’ vote.. 16.

(26) While the abovementioned principles and recommended practices are very specific with regard to executive remuneration, there are other principles and recommendations that, though not directly related to executive remuneration, address remuneration philosophy and strategy. Considering that corporate governance is the responsibility of the board and that the board should take ownership of the remuneration decisions of its executives, an overview of the principles as they pertain to the board is necessary. An overview of these principles as they relate to the board is found in Table 3. Table 3 is divided into sections according to the governance elements that govern the principles and recommended practices. In the left column, the principle is given, paired on the right with the recommended practice. The numbering in the table is in accordance with the relevant section numbers as contained in King III.. 17.

(27) Table 3 King III principles and recommendations relevant to boards (From IoD, 2009, pp. 19-48). Principle(s). Governance Element: Ethical leadership and corporate citizenship (Responsible leadership). 1.1 The board should provide effective leadership based on an ethical foundation. IoD, 2009, p. 19. Recommended Practice Ethical leaders should:. 1.1.1. direct the strategy and operations to build a sustainable business; 1.1.2. consider the short- and long-term impacts of the strategy on the economy, society, and the environment; 1.1.3. do business ethically; 1.1.4. do not compromise the natural environment; and 1.1.5. determine the company’s impact on internal and external stakeholders.. Governance Element: Ethical leadership and corporate citizenship (The board’s responsibilities). Principles(s). 1.1 The board should provide effective leadership based on an ethical foundation.. Principle(s). IoD, 2009, p. 20. 1.1.8. ensure that its conduct and that of management aligns to the values, and is adhered to in all aspects of its business.. The board should:. 1.1.10. ensure that all deliberations, decisions, and actions are based on the four values underpinning good governance;. Governance Element: Boards and Directors (Role and Function of the Board) Recommended Practice. 2.17. The board should appoint the chief executive officer and establish a framework for the delegation of authority. IoD, 2009, p. 25. 1.1.7. Set the values to which the company will adhere formulated in its code of conduct; and. Governance Element: Ethical leadership and corporate citizenship (Ethical Foundation) Recommended Practice. 1.1 The board should provide effective leadership based on an ethical foundation.. Principle(s). Recommended Practice. The board should:. 2.17.1. appoint the CEO; 2.17.4. ensure that the role and function of the CEO is formalised, and that the performance of the CEO is evaluated against the criteria specified; and 2.17.5 ensure that succession planning for the CEO and other senior executives and officers is in place.. 18.

(28) It is important to note that the board is specifically reminded that cognisance should be taken of the impact of board decisions on all stakeholders. This cognisance is also of relevance in executive remuneration, especially considering the current dissent regarding executive remuneration. Table 4 (below) provides an overview of the ethical principles and recommended practices that should govern a board's decision-making. In the left column, the principle is given, paired on the right with the recommended practice. The numbering in the table is in accordance with the relevant section numbers as contained in King III. Table 4 King III principles and recommendations relevant to board decision-making (From IoD, 2009, pp. 19-48) Governance Element: Compliance with laws, rules, codes, and standards. Principle(s). 6.1. The board should ensure that the company complies with applicable laws and considers adherence to nonbinding rules, codes, and standards. IoD, 2009, p. 42. Principle(s). 6.1.3. Compliance should be an ethical imperative. 6.1.6. The board should monitor the company’s compliance with applicable law, rules, codes, and standards.. Governance Element: Governing stakeholder relationships. 8.1. The board should appreciate that stakeholders’ perceptions affect a company’s reputation. IoD, 2009, p. 46 8.3. The board should strive to achieve the appropriate balance between its various stakeholder groupings, in the best interests of the company. IoD, 2009, p. 47 8.5. Transparent and effective communication with stakeholders is essential for building and maintaining their trust and confidence. IoD, 2009, p. 48. Recommended Practice. Recommended Practice. 8.1.1. The gap between stakeholder perceptions and the performance of the company should be managed and measured to enhance or protect the company’s reputation. 8.3.1. The board should take account of the legitimate interests and expectations of its stakeholders in its decision-making in the best interests of the company.. 8.5.1. Complete, timely, relevant, accurate, honest, and accessible information should be provided by the company to its stakeholders, whilst having regard for legal and strategic considerations. 8.5.2 Communication with stakeholders should be in clear and understandable language.. 19.

(29) Tables 2 to 4 create a sense that executive remuneration may not be such a complex affair after all, as the recommended practices might self-fulfil the demands of the principles. To gain an appreciation of the complex landscape within which these principles would require application, an exploration of executive remuneration is warranted.. 2.4. Executive remuneration. According to Kidder and Buchholtz (2002, p. 608), remuneration is the most explicit symbol of appreciation, accomplishment, and dignity. As such, it sends a message to the executive, not only about past accomplishments, but also the extent to which the board trusts the executive to contribute to organisational performance in the future. For the purposes of this study, remuneration is defined as “an amount of money that is paid to somebody for the work they have done,” as defined by the Oxford Advanced Learner’s Dictionary (2010, p. 1247). This definition is also in accordance with those of King III (IoD, 2009) and Bussin (2011). Another term often used in this regard is 'compensation.' While 'compensation' is accepted in the business environment as an interchangeable term for 'remuneration,' it can, however, also denote being compensated for having suffered some misfortune or loss. Therefore, for purposes of this research, the term remuneration is preferred. Remuneration can consist of various components, such as the total guaranteed package, short-term incentives, long-term incentives, retention payments, and ad hoc payments, which all serve a different purpose in the overall remuneration of executives (PriceWaterhouseCoopers, 2011, p. 8).. The various components of remuneration, their. nature, and their purpose are illustrated in Table 5.. 20.

(30) TABLE 5 Components of executive remuneration (from PriceWaterhouseCoopers, 2011, p. 8). Remuneration. Ad hoc. TGP (Total guaranteed package). STI (Short-term incentive) LTI (Long-term incentive) Retention. -. Sign-on payments ‘Golden parachute’ payments Restraint of trade payments Consists of base salary and benefits. -. Payments for doing the day job Recognises status and responsibilities Provides basic benefits, including retirement funding. -. Creates a performance culture. -. Supports short-term operational objectives Rewards achievement of financial and personal targets. -. Long-term focus. -. Alignment of executives and shareholders. -. Retains key talent. -. Addresses the skills shortage. This representation of the components of remuneration concurs with one presented by Bussin (2010, p. 3) as "The full remuneration framework as applied in South Africa." This interpretation also appears to be supported by Matsumara and Shin (2005), who describe executive remuneration packages as usually consisting of four major components, namely basic fixed salary, annual bonus, stock options and restricted stock grants, and long-term incentive plans. Matsumara and Shin (2005) point out that basic salary is often determined by a comparative analysis of the salaries of peers within the same industry, while the bonus is usually dependent on a measure such as accounting performance for a given year, or earnings per share. A stock option is the manner in which the company gives executives the right to buy the firm’s shares at a pre-specified exercise price for a pre-specified term. Long-term incentive plans differ from bonus payments, in that bonus payments focus on the performance of a single year, while the incentive plan takes a longer-term view and takes into account the. 21.

(31) performance of the executive over a period of about three to five years. The above definition of remuneration is further supported by the new Companies Act, which defines remuneration as “ ...all encompassing, including fees, salary, bonus, pensions, compensation for loss of office, detail of service contracts and securities issued” (Delport, 2009, p. 31). This brief overview of the elements of remuneration facilitates an understanding of executive remuneration packages. 2.4.1. Executive remuneration: reason for concern?. “There are remuneration packages that will no longer be tolerated because they bear no relationship to merit. That those who create jobs and wealth may earn a lot of money is not shocking. But that those who contribute to destroying jobs and wealth also earn a lot of money is morally indefensible.” President Nicolas Sarkozy at the opening of the 40th World Economic Forum (2010, p.4). The above sentiment appears to be supported by the South African Finance Minister, Pravin Gordhan, as well as the Secretary General of the African National Congress, Gwede Mantashe. In his budget vote speech to Parliament, Finance Minister Pravin Gordhan is quoted as having said, “Extreme earning disparities cause offence not just when associated with profiteering or financial malfeasance, but also when the reward for honest work seems disproportionate or weakly aligned with incentives. We are creating a dangerous culture in South Africa” (May 11, 2010). This sentiment was echoed by Mantashe in Fin24.com, where he was reported to have said that “Bloated executive remuneration becoming the norm is not good for a developing economy with high inequality levels like those in South Africa” (Mantshantsha, 2010). The following articles, published in local newspapers, sketch the background to the above statements: The Star, May 26, 2010 ‒ “Directors were paid R20 000 per meeting and 22.

(32) the chairwoman got R25 000.” and Business Report, May 27, 2010 ‒ “Controversial R7.5 million golden handshake,” where it is further reported that “the R7.5 million bonus would be paid to the then chief executive officer, of organisation Y, after he had already received a generous fee which formed part of his R2.2 million package in 2000.” In another article, it was reported that executives of South African banks were found to earn an average of R10.3 million per annum, with one executive who retired recently having earned R43 million per annum (Van Rooyen, 2010). The Sunday Times's Rich List of November 1, 2009 (2009, p. 3) discloses the following: in 2008, the former chief executive officer of BHP Billiton earned R411.6 million, with R380 million from share earnings. A then-executive of Mvelaphanda Resources earned R15.8 million during that year, which included a R12 million long-term retention bonus and a R2.5 million termination benefit – implying that he was paid both to stay and to leave in the same year. A former SABC executive was given a R12 million 'golden handshake' despite leaving the broadcaster in no better position than that in which he found it. The report further states that “this continues a fine tradition that reached an arguable high point in 2002 when Coleman Andrews was paid R256 million to leave South African Airways” (Sunday Times, 2009, p. 6). It was also recently reported that a strike by Eskom unions was imminent due to wage negotiations. Eskom’s latest (2010) annual report, as reported in Fin24.com, showed that the former CEO of Eskom, Jacob Maroga, received a short-term bonus of R1.2 million, paid after the termination of his contract. The newly-appointed chief executive officer of Eskom, Brian Dames, received an increase of 91% on his total remuneration for 2009. It was further reported that executive committee members of Eskom received an average 59% cash increase on their 2009 remuneration, while the union’s demand for a 9% wage increase was dismissed as outrageous (Mantshantsha, 2010). A year later (2011), this perceived excess appears to have continued unabated, with reports stating that Eskom paid its executive 23.

(33) committee members 109% more than in the previous year. The biggest increase was 507%, which was awarded to their head of human resources (Styan, 2011, p. 1). The latter is but one example of the “extreme earning disparities” that Finance Minister Pravin Gordhan was referring to. From this overview it appears that executive remuneration is cause for concern in the governance landscape of South African organisations. What, however, are the debates and determinants that surround the calculation and payment of executive remuneration packages? 2.4.2. The principal-agent relationship and executive remuneration.. Before the determinants of executive remuneration are explored, a brief overview of the principal-agent relationship and its relevance to executive remuneration is provided. The principal-agent relationship refers to the fact that organisations are, to a large extent, no longer owned and controlled by the same entity, and with the separation of ownership and control, there is a need to ensure that those in control of the organisation do so in the interest of those who own it (Matsumara & Shin, 2005). Owners are also referred to as principals or shareholders, while the executives of organisations are referred to as agents of the principals. It is assumed that, should an executive control an organisation, this control would be wielded in the executive's own best interests, thereby assuming that all individuals are, at heart, selfserving. Executive remuneration packages are utilised in an attempt to align the interest of the executives and shareholders. Nichols and Subramaniam (2001, p. 345) state that the primary purpose of executive remuneration is an attempt to reduce the conflict between shareholders and executives and align the interests of these two groups, a view that appears to be shared by Matsumara and Shin (2005). An effective executive remuneration package is viewed as a manner in which the needs of these two seemingly opposing parties (shareholders and executives) can be aligned, which is why remuneration packages often include share24.

(34) based payments. It is believed that, in this way, the executives gain a direct interest in the organisation. Approaching the establishment of executive remuneration packages from a simple principal-agent relationship point of view appears to be not without some risks. Kidder and Buchholtz (2002), citing studies by Baysinger and Hoskisson (1990) and Hill and Snell (1988), found that the more remuneration packages are used to monitor executives’ behaviour, the more the executives became risk averse. A similar train of thought is shared by Perel (2003), namely that constraining the remuneration packages of executives might have the undesirable effect of making executives risk-averse and lacking in innovation, resulting in ineffective leadership. While a focus on the principal-agent relationship might have had some merit in the past, it appears to have some negative consequences in the fastpaced business world of the 21st century where risk-taking and innovation are highly soughtafter skills. This then raises the question what other measures could be considered in the determination of executive remuneration packages. 2.4.3. Determinants of executive remuneration.. In a pragmatic approach to the issue of executive remuneration, the executive remuneration packages could be determined according to organisational performance, as this would seem both logical and fair. Another consideration could also be the risk profile of the position, where the need for risk-taking associated with a position is rewarded. The value of everything in the economic world is determined by supply and demand in the market, which could be another determinant of executive remuneration.. Determining this supply and. demand can be left to remuneration consultants, who then, in turn, can recommend a package for the executive, which could be informed by market surveys. There are, however, factors in the micro- and macro-environment that would need consideration in the determination of 25.

(35) executive remuneration packages, such as the organisational remuneration strategy and the socio-economic issues within the country. Below is a discussion of these seven determinants of executive remuneration, namely organisational performance, risk propensity, supply and demand in the labour market, market surveys, remuneration consultants, remuneration strategy, and socio-economic issues. 2.4.3.1 Organisational performance.. It seems apparent that organisational performance should be a prime measure or standard in the determination of remuneration packages at the executive level. It could be argued that the organisation performing well is in the interest of shareholders as well as the executive concerned, and, therefore, an alignment of interests between executive and shareholders is guaranteed. Perel (2003), however, believes that a major component of executive remuneration is unrelated to organisational performance.. Nichols and. Subramaniam (2001, p. 347) cite similar thinking by referring to Jensen and Murphy (1990b), who state that “the weight of the evidence points towards a small, almost inconsequential relationship between firm performance and CEO pay.” This apparent lack of a relationship between organisational performance and executive remuneration is illustrated by Vignette A.. 26.

(36) Vignette A:. Inconsequential relationship between firm performance and executive. remuneration. . Newspaper reports state that the Grindrod executive director received a R31.97 million performance bonus – while Grindrod earnings per share fell 63% (Vollgraaff, 2010, p. 3).. . Another executive is reported to have received a R13.61 million bonus in the year his group’s headline earnings per share fell 77% (Vollgraaff, 2010, p. 3).. . It is hardly surprising that one then finds headlines reading: “Performance formula as clear as mud” (Marais, 2010, p. 3).. . “Among South Africa’s top 100 earners, there are only 13 who did not get a performance bonus last year. Yet 39 of the 100 companies they managed reported lower earnings” (Sunday Times Editorial, September 4, 2011).. . “Lonmin’s directors were also patted on the back with six-digit performance bonuses despite a fall of 145% in the company’s headline earning” (Vollgraaff, 2011).. Vignette A illustrates that even though performance might be touted as an indicator of the level of executive remuneration, it is not what tends to happen in practice. On the contrary, the above vignette illustrates that there could even be an inverse relationship between organisational performance and the level of executive remuneration. Even if ‒ contrary to findings of research and newspaper articles ‒ organisational performance ought to be a good indicator of the efficacy of executive remuneration strategies, it raises concerns regarding the performance indicator. Would a downward turn in organisational performance be an indication of poor executive remuneration, or would it merely be a function of the prevailing economic climate, such as the current recession? Another consideration to bear in mind is that, should organisational performance be a measure of executive remuneration, it would not necessarily satisfy the key element of the principal-agent relationship, namely alignment of the interests of executives and 27.

(37) shareholders. It could be argued that executives might be tempted to inflate performance results in order to ensure a commensurate increase in remuneration. Kidder and Buchholtz (2002, p. 601) suggest that adopting a principal-agent perspective may lead to self-serving behaviours, a view similar to that of Rodgers and Gago (2003, p. 189), who established that some executives with powerful incentives to enhance their remuneration had inflated their organisations’ financial results. Matsumara and Shin (2005) make a similar observation: that fraudulent behaviour may occur in order to increase remuneration. Perel (2003, p. 384) believes that a drive for better organisational performance should be accompanied by a concurrent focus on ethical behaviour, otherwise executives might act recklessly to maintain their remuneration and keep their jobs. Perel (2003, p. 387) further cites the example of Enron, where executives manipulated the organisation's earnings to raise the firm’s stock price and vastly increase the value of their stock options. When adopting the simple approach of purely rewarding performance, the question can also be asked whether achievement is being encouraged at the cost of other stakeholders. King III advocates an inclusive approach to corporate governance, defining it as: "the board considering the legitimate interest and expectations of all stakeholders on the basis that this is in the best interest of the organisation, and not merely as an instrument to serve the interests of the shareholder" (IoD, 2009, p. 12). In view of this statement, basing remuneration purely on performance seems contrary to the inclusive approach. Perel (2003, p. 383) supports this view in that he believes that the focus on performance has caused executive remuneration to be firmly based on stock prices, which implies a focus solely on shareholder returns to the possible detriment of other stakeholders. Another consideration when basing remuneration on performance is that if the principle of rewarding performance is reserved for certain classes of employees, to the exclusion of the rest of the workforce, it could be contrary to an inclusive governance 28.

(38) approach. While executive remuneration might have a very clear link with performance, less senior members of the workforce are often remunerated annually on a negotiated, across-theboard increase with little or no link with performance. This scenario exemplifies the concern mentioned earlier, that although corporate governance advocates an inclusive approach, some practices might be considered contrary to this and inadvertently promote an approach based purely on the interests of shareholders. One of the consequences of linking the remuneration package to organisational performance is that transparency might be compromised. Vignette B: . Lack of Transparency. “...CEO of Telkom, Pinky Moholi failed the transparency test by not revealing to curious shareholders just why it made secret payment of R66.5 million to six executives in the past two years” (Rose, 2011).. . “The furore over the paying out of bonuses and large salaries is symptomatic of a broader management problem where companies are not transparent with staff about the true state of their financial affairs” (Business Report, March 2010).. . Lack of transparency on the calculation of performance bonuses, the setting of targets for executives, and companies' remuneration policies remain causes for concern, says shareholder activist Theo Botha (Marais, 2010, p. 3).. Vignette B illustrates that using organisational performance as a determinant of executive remuneration increases the temptation to not adhere to one of the core ethical values of governance, namely transparency. Lawler (1990, p. 20), however, believes that this can be counteracted by making the link between pay and performance clearer by making information about the remuneration system public. 2.4.3.2 Risk propensity.. Another aspect that could be considered in the determination of the remuneration package of the executive is that remuneration could be considered a function of the 29.

(39) differential risk borne (Nichols & Subramaniam 2001, p. 345). Executives carry far greater risk and responsibility than anyone else in the organisation. The issue is how this risk is calculated to determine a commensurate remuneration package. 2.4.3.3 Supply and demand in the labour market.. Perel (2003, p. 386) believes that remuneration packages of executives should have a direct relationship with the value of the services and the amount a future employer is willing to pay. Executives, by virtue of their skills, are in short supply which, according to Nichols and Subramaniam (2001), makes large remuneration packages inevitable. The economic world is regulated by market supply and demand, and this principle is also at play in the remuneration packages of executives.. However, how much of this determination is. objectively done, and how much is due to corporate vanity in an attempt to have a good public relations moment when announcing new executive remuneration packages? Perel (2003, p. 383) is of the opinion that, even though this scarcity of capable executives drives up their price, their very performance is by no means guaranteed. This is a view that appears to be shared by Icely, who, according to an article by Bonorchis (2011), is reported to have said that “a sense of entitlement appears to exist”, and “South African companies seem to be holding on to the myth of the indispensible executive.” Kolb (2006, p. 480) quotes Wilhelm (1993) who concluded that “the corporate board must recognize that surveys are bogus and CEO mobility is really low.” Vignette C: . Supply and demand in the labour market. “Companies claim to believe in the free market system, where success is rewarded and failure punished – but some choose to ignore this when it comes to enriching their executive team” (Sunday Times Editorial, September 4, 2011).. 30.

(40) Vignette D: . Money does not retain. Cosatu spokesperson Patrick Craven, in an article published by fin24.com and in reference to the publishing of the “Rich List,” refutes the argument that executives need to be rewarded with huge packages as a manner to retain, as 20 of the top 100 highest-paid executives in 2010 are no longer in their positions today (2011). “Companies and the big parastatals argue that they need to pay well to retain top skills. This claim, however, can be challenged, as 21 of the 100 top earners of corporate South Africa in 2010 are no longer in their jobs a year later. At parastatals, the turnover of top executives is even higher” (Sunday Times Editorial, September 4, 2011).. . “Big pay cheques do not seem to mean loyalty to a company as Ballandino is not the only person on the list of 100 biggest earners who is now a former director” (Vollgraaff, 2011). “...making a mockery out of claims by many companies that they need to pay excessive salaries, and dish out huge share options, retain top skills” (Peacock, 2011).. Vignettes C and D illustrate that, although it could be argued that supply and demand could be used to determine executive remuneration packages, huge values by no means ensure the retention of executives. This is aligned to Pfeffer’s (2001, p. 144) thinking – he believes that one of the myths regarding remuneration is the assumption that people essentially work for money. He states that companies that ignore the fact that employees essentially work to have meaning in their lives are doing nothing more than bribing their employees. He further believes that these companies will ultimately pay the price in the form of a lack of loyalty and commitment (Pfeffer, 2001). 2.4.3.4 Market surveys.. Another factor that could be considered in the determination of executive remuneration packages is research conducted in the market on remuneration received by peers within the same industry. Paying executives high remuneration in relation to their peers is frequently a case of little more than corporate vanity (Perel 2003, p. 383). Matsumara and Shin (2005) have a similar opinion, stating that executive remuneration disclosure may turn executive remuneration into a “beauty contest,” leading to increased 31.

(41) levels of remuneration as firms seek to ensure that their executives are among the highest paid. Kolb (2006, p. 131), however, has a slightly different view on this, in that he believes that there appears to be some indication that executive remuneration surveys conducted by independent remuneration consultants may be skewed upward because the companies that respond do not want to damage their future recruitment and retention efforts by being perceived as paying less competitive remuneration. Vignette E: . Market surveys are not an exact science. Seeger (2010, p.1), of PriceWaterhouseCooopers SA, notes that “companies must stop trying to be at the median of the corporate remuneration scale and rather pay relative to the market, based on their own circumstances. Not everyone can be at the median.”.  . Reported in the Sunday Times of 5 December 2010: “...huge severance payments, lavish perks and outsized payments for ho-hum performance often occur because compensation committees have become slaves to comparative data. The committee is told about new perks that other managers are receiving. When compensation committees follow this ‘logic,’ yesterday’s most egregious excess becomes today’s baseline” (Laing, p. 5).. It appears that, although market surveys or comparisons with peers in the industry seem to be a scientific approach to determining executive remuneration, this system might have some flaws. In this regard, Darcy quotes Warren Buffett as having written to his executives that the five worst words in the business lexicon are "everybody else does it" (2010, p. 205). 2.4.3.5 Remuneration consultants.. Organisations often recognise that they might not be competent to establish executive remuneration packages and, as a result, engage the services of remuneration consultants. “Thus organisations seeking to legitimise top-team pay setting are likely to use consultants as a legitimising conduit” (Conyon, Peck & Sadler, 2011, p. 33). Conyon, Peck and Sadler quote Bebchuk and Fried (2003, p. 78), who claim that “consultants would be loath to 32.

(42) provide advice that hurts the CEO’s pocketbook, as it is hardly a way to enhance the consultant’s chances of being hired in the future by this organisation or any other organisation” (Conyon et al., 2011, p. 39). Conyon et al. found that, in approximately 60% of the cases examined, the remuneration consultant supplied other business services to the firm (2011, p. 46), which led them to conclude that “the compensation of CEOs in organisations where the consultant provides other business services was found to be significantly higher than where the consultant does not” (2011, p. 52). This finding implies that the determination of remuneration packages for executives, even when done by a third party, is neither an exact science nor an objective process. However, all of the abovementioned determinants of executive remuneration should be taken into consideration when determining a course of action that would be in line with the remuneration strategy of the organisation. This is discussed in more detail below. 2.4.3.6 Remuneration strategy.. An organisational strategy informs organisations regarding which actions to take on a daily basis in order to achieve a competitive advantage. As explained by Kirkpatrick (2009, p. 10), “...the board is responsible for reviewing and guiding corporate strategy.” This business strategy, however, needs to be supported by the remuneration strategy (Bussin, 2003). As the business strategy determines the actions the organisation will take to gain competitive advantage, so will the remuneration strategy determine how the board and remuneration committee deal with the challenges and approaches raised in the previous sections.. The remuneration approach should be formalised in the remuneration policy.. Bussin (2003) found the top five drivers in order of strength with regard to remuneration policy to be: retention of key staff, financial results, strategic thrust, surveys/benchmarking, and internal advisers. What is of concern, however, is that, in the study conducted by Bussin. 33.

(43) (2003), it was found that, out of 24 factors driving change to remuneration policy, governance was ranked only 21st. 2.4.3.7 Socio-economic issues.. Socio-economic issues are another factor that needs to be taken into consideration when dealing with executive remuneration, especially in South Africa, which has been described as one of the most unequal societies in the world. It is an undisputed fact that South Africa carries the legacy of apartheid, which is typified by an uneven distribution of wealth, not only amongst the different races, but also between the genders. Vollgraaff (2011) reports that “Women account for about 52% of the SA population and slightly more than 45% of the labour force, but even the richest women in SA still languish far behind their male counterparts when it comes to earnings and wealth” (Sep 4, 2011). Lawler (1990, p. 23) goes one step further, stating that; The key from a reward system point of view is to develop a pay system that reinforces the development of the right skill mix. And the reward system needs to do this not just at the senior management level but at all levels in the organisation. This statement, made more than twenty years ago, is even more relevant in the current South African context, where skills development has become imperative. Vignette F: . Lack of transformation. “Len Konar took home R3.8-million from the seven companies he is director of...” (Lefifi, 2011).. Comparing the remuneration of executives with that of the rest of the workforce in organisations gives rise to another concern ‒ that of differential remuneration within organisations. While Nichols and Subramaniam (2001) refer to the differential risk borne by these two categories of employees as a possible reason for the differential remuneration, Perel 34.

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