December 23, 2014

Equities are an attractive asset class, particularly at a time when the world is travelling down its current unprecedented monetary path. This is the case as the underlying companies can be robust assets whose prices provide inflation-beating returns in the longer term. Contrasting this, there is no hiding that equities are risky, having to face an uncertain future and constant change as well as eternal competition. An issue has developed over the last few decades which is further increasing the risk of equities: excessive senior management remuneration, and especially that of the CEO. This has and continues to drain away returns from equities, and hence decreases their attraction for shareholders.

The growth in top managements’ remuneration is a matter of much public anger. Where the average worker hasn’t seen real increases in wages in twenty years, CEO remuneration has sky-rocketed. At times, this has reached ridiculous levels. Let us look at one specific example: a few years ago, our research into a potential investment in the education industry revealed that the CEO was paid $41m in a year when the company made a profit of $131m. We did not invest. Another current example is Chipotle Mexican Grill where pay for 2013 is approximately $25m each for the two CEOs, and a total of $126m over the last three years. This is simply too much to pay someone to do their job. These are but two examples amongst many.

The crux of the problem is that directors and shareholders have over-inflated opinions of the importance of this role. We have come to believe in the existence of a super-human character who can single-handedly grow sales and EPS year in and year out (without accounting fudges, please), protect the company from all manners of legal and regulatory ills, and look good on the cover of business magazines while doing it. This shows a fundamental misunderstanding of the nature of businesses. Most companies are successful because of their positioning in the market – their distribution strength, their brand and reputation, their location, or by the business decisions and contacts that are made across the whole organisation. The CEO is a very important role but he or she is still only one member of the team. The company can function without the CEO, but the CEO is nothing without a company. It is this misunderstanding that allows CEOs to be gifted significant percentages of the companies that they are running. It is unnecessary and excessive.

What should be done? A few suggestions:

  • Ban remuneration committees from using average executive remuneration tables. These suffer from eternal escalation as every company pays above average (who would admit to being below average?), which spirals average pay continuously.
  • Set reasonable targets, ones that relate to the long term, and stretch payouts over many years, by which we mean ten years or more. If it turns out after a few years that the value created was illusory, remuneration is still there to be cut. This also has the benefit of forcing management to think about the long term health and sustainability of their enterprises.
  • Limit the payouts to a respectable absolute amount of money. Being a CEO is very desirable, due to the prestige and job satisfaction, and we see no reason to earn more than £5million a year. In total.

In short, be patient with mistakes and problems, don’t expect miracles, and don’t believe that everything that goes right (and wrong) is all down to the CEO. There are very few true super-heroes, so don’t pay every CEO like one.

At Kennox, we are happy to approve those which are fair and align with shareholders and other stakeholders for the long term. These are disappointingly few and most remuneration packages we find to be excessive, so we vote against them. Current systems of remuneration focus too much on the short term and award huge riches to the good and the bad alike (and especially the lucky). The pendulum has swung too far, and it is time it started swinging back.

This piece originally appeared in Professional Adviser (October 2014)

Authorised and regulated by the Financial Conduct Authority (FRN: 475658)
The Company is based in Scotland, UK with the above registered address (Registered Number: SC302037).

© Copyright 2022 Kennox Asset Management
chevron-down linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram