Shareholder Revolts Hide a Deeper Problem


Aviva (NYS: AV) and its ex-CEO Andrew Moss recently hit the headlines when it became only the fourth FTSE 100 company to ever suffer a shareholder defeat on an executive-pay vote.

The shareholder spring has also seen thundering discontent amongst the shareholders of businesses as varied as RBS, Barclays, AstraZeneca, Trinity Mirror, and William Hill. There seems to be no common thread in terms of company performance -- some are doing well, some less so.

Missing the point?
The trigger for protests is usually some particularly outrageous pay statistic, sometimes coupled with disappointing share-price performance or simply a perception that bosses are not showing the same attention to shareholders' rewards as to their own.

All of this is perfectly valid, but I think that we are missing the bigger problem, which is that executive-pay policies should be transparent and directly linked to the performance of the executive's primary duty: the creation of shareholder value.

Up the garden path
A company director's legal duty is to manage the company's assets on behalf of its beneficiaries, the shareholders. Logically, it follows that directors should be rewarded in direct proportion to their success at increasing the value of these assets.

Instead, executive directors' salary and bonus payments are often tied to a mind-numbingly complex array of key performance indicators. These often sound plausible at first but turn out to be overly complex, easy to fudge, and impossible for shareholders to accurately evaluate.

Shelling out
For example, one member of the FTSE 100 pay-revolt club is Royal Dutch Shell (NYS: RDS.B) , whose remuneration report was voted down by shareholders in 2009. This was caused by Shell's decision to fudge its own peer-comparison score and award its directors huge bonuses in a year when operating profit halved.

Today, things have changed a bit -- but not much.

According to Shell's 2011 annual report, the scorecard used to calculate executive directors' annual cash bonuses is made up of the following three elements:

  • 30%: cash flow. "Cash generated from operations that factors in the impact of commodity price fluctuations as well as business performance."

  • 20%: sustainable development. "Equally weighted indicators of safety and environmental performance."

  • 50%: operational excellence. This is based on project delivery targets and hydrocarbon production, which includes sales targets and plant availability.

Most of these metrics are impossible for shareholders to evaluate and are not directly related to net income or dividend payments. This becomes obvious if you look back at the cash earnings (excluding stock options) of Shell's CEO over the past five years:


(in Pounds)

% Change


% Change


% Change










































Source: Royal Dutch Shell annual reports.

Over the past five years, the annual cash compensation of Shell's chief executive has increased by 40%, but during the same period the dividend has increased by just 16% and operating profit is lower than it was five years ago.

Of course, Shell's profits are linked to the price of oil, over which it has little control. It's also true that companies often choose to accumulate cash during the good times so that they can pay a stable dividend in lean years. Yet there is no denying that the biggest winner here is Shell's CEO.

Any better at Aviva?
Things aren't much better at Aviva, either, where the bonus criteria are hugely complex. I did manage to work out that in 2011, Andrew Moss' bonus included a weighting of between 6.3% and 14.6% for operating profit, but some of the other targets that contributed to his bonus, such as "employee" and "common risk objective," were impossible to understand.

My colleague Cliff D'Arcy recently took a look at Aviva's pay and dividend history and found that total executive pay has risen by 8% over the past five years while dividend payments have fallen by 21%.

There is another way!
Wouldn't it be nice if top management took pay cuts in really bad years? If a fall in operating profits meant a reduction in total pay? You may think this sounds hopelessly naive, but it does happen in some companies.

A recent Investors Chronicle blog made the point that in Germany, executive-pay polices are much simpler and more transparent and often are directly linked to recognizable financial metrics, like operating profit and return on sales. The author noted that at Allianz -- an insurance giant with similar problems to Aviva -- top executive pay actually fell last year, as income targets were not met.

German supremacy?
To put this theory of German corporate transparency to the test, I selected a large German corporation at random and looked at its annual report. The first company I chose was Siemens, and the difference was immediately obvious.

In just a few seconds, I found a table containing the criteria, target figures, and actual figures used for calculating the executive directors' bonuses in 2011. The measures used were both familiar and relevant to shareholders -- especially free cash flow, from which dividends are normally paid:

  • Organic revenue growth (50%).

  • Return on capital employed (25%).

  • Free cash flow (25%).

Of course, the targets themselves could still be too easily attainable, but any shareholder familiar with the company should be able to recognize this quite easily, unlike with Shell's cryptic bonus criteria.

Your vote doesn't count
The final straw is that when U.K. shareholders do manage to vote down an excessive executive-pay proposal, it doesn't really matter. The pay votes are not binding, only advisory.

Although a defeat is embarrassing, companies are not obliged to act on them, and some don't. Thankfully, this is set to change, following the successful efforts of Business Secretary Vince Cable to get binding shareholder votes on executive pay added to company law.

This is good news, but I worry that it won't address the real issues with executive pay -- it is deliberately hard to understand and is not closely linked to performance measures that benefit shareholders.

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At the time thisarticle was published Roland Head owns shares in Royal Dutch Shell and Aviva but owns none of the other shares mentioned in this article. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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