Evan Thornley

As a second-year university student, I read Stephen Robbins’ textbook on Organizational Behavior (like all management theory in Australia, it was imported from the US – hence the spelling) and came across a new idea – “the managerial imperative”. I never did an MBA but many people who have assure me that “the agency problem” (the same issue) is a core part of the curriculum in any reputable school. Strangely, the issue doesn’t seem to have had much of an airing in the public sphere beyond business academia. Gideon Haigh’s outstanding essay places a welcome spotlight on it.

Agency theory runs counter to the quaintly selfless model of “master and servant” that begat modern capitalism – it suggests that managers’ interests may be different from, or even contrary to, those of the shareholders that ultimately hire them. When you give it a moment’s thought, it seems pretty obvious. As a certain former Labor prime minister was fond of saying, “In the race of life, always bet on self-interest – at least you know it’s trying.”

While no one doubts the vital importance of getting the best management if a business is to compete successfully, the question becomes, at what price? Who determines what management is paid, how performance is assessed, and who assesses the assessors?

That a small “club” runs most of “the big end of town” in this country is not a new observation. There is little deviation from the common interests shared by the group. Despite a certain level of competition and personal rivalry, for the most part “what happens on the field stays on the field”, as the footy players are fond of saying. As most of the boards of directors are drawn from this management group, its control of the organisations is further strengthened. In another era when such things were more popularly the subject of genuine analysis, the common interests of this group of senior managers might even have been said to amount to a “class”. Heaven forbid, the social construct that dare not speak its name!

It is no longer fashionable to talk about class – for some reason the collapse of totalitarian communism (itself the result of the total dominance of its own managerial class – the political apparatchiks) is taken as self-evident proof that class analysis – indeed political analysis generally – no longer has a role to play. Haigh’s essay shows that it does – although I freely concede that Haigh himself may not welcome this interpretation or terminology.

What we have here is the rise and rise of the managerial class: a distinct and separate set of interests from the respective interests of employees, shareholders and customers. Look at many Australian companies over the last two decades and you can see this trend emerging very clearly at the place where all class analysis begins – the economics. In too many of our companies we have seen workers forced to accept sub-real wage increases, shareholders receive sub-cost-of-capital returns, and customers pay exorbitant prices resulting from monopolistic and oligopolistic industry structures.

One group, though, has made out like bandits – senior management. As Haigh points out, the rise in CEO and other senior management salaries has outpaced any other index of economic benefit for shareholders, customers or workers. By a mile!

What price failed management?

No one seriously doubts that the quality of management is among the most important factors in any business. As in all avenues of life, leadership is always the scarce resource. The issue is, at what price? In particular, how do you judge good management from poor and how should that affect the rewards paid to managers?

At any given level of managerial competence, as the costs of payments to management increase, profits and shareholder returns must therefore decrease. Even if a given level of profit is to be maintained for shareholders, then these managerial cost increases must be offset elsewhere – either at the expense of customers (through higher prices), workers (through lower wages) or suppliers, many of whom are smaller companies less able to respond.

In this way the interests of the managerial class are economically opposed to the interests of almost all other groups of society in a simple and mathematical way.

When I discussed this recently with some of my colleagues in business, they expressed a concern that this was returning to the bad old days where we talked about “how the pie is distributed” rather than “how to grow the pie”. The theory is that good management “grows the pie” and is therefore entitled to a share of the benefit. It’s a great theory.

In practice we have seen senior management pay rising at about 15 per cent compound per annum and no other aspect of “the pie” has grown as fast. So whether we want to talk about it or not, the pie is being redistributed.

It is important to spend more time talking about how to “grow the pie”, but when those who say “Why are we going back to the bad old days of talking about distribution?” are in fact the prime beneficiaries of the largely silent redistribution of the last two decades, the plea rings a little hollow.

And it rings even more hollow when we ask how successfully Australian management is “growing the pie”, especially in the face of the onslaught of international competition. Every once in a while someone speaks up for “our business leaders” and laments that we do not laud their achievements in the same way that we do our sporting heroes. It is said that this is “the tall poppy syndrome” in action. I disagree. As usual, the punters have got it largely right. Most of our sporting heroes are acclaimed for being truly the best in the world – our swimmers, cricketers and even, on occasion, our downhill skiers.

How many of our CEOs could credibly claim to be the best in the world? The few I can think of who are in there with a shout are also those who run, or ran, the companies they founded. Dick Pratt, Rupert Murdoch and a few others at least have a shot at such a title in their respective industries. A tiny number of other truly world-class companies apparently have truly superior management teams – it’s hard to think of any among our larger companies, but perhaps in the minor leagues a niche specialist like Cochlear could claim to be a true world leader in its field.

John Button reports in his memoirs a conversation with Sir Peter Abeles in which Abeles asked Button how many good CEOs he thought there were in Australia. Perhaps typifying modern Labor’s reluctance to criticise business performance for fear of being seen to be anti-business in general, Button cautiously replied, “Twelve.” As Button records, Abeles replied, “I think you’re being generous. I think there are ten.”

In the tough world of global competition, we have almost no Australian companies, other than in resources, who generate even $1bn in exports. In a globalising economy where we have opened our markets and removed our tariff barriers to international competition, the capacity of our companies to do likewise and invade others’ markets will determine our place in the world. To date they have largely failed. By and large this provides the reason why most Australians are appalled by the cult of the CEO and its economic results – quite simply, “They’re not worth it.” This has been highlighted by the extraordinary cases of payout for failure. The press, in a rare display of business acumen, has said enough on this particular topic that I don’t need to press it further. Some of the debate has also been confused, however, with payouts to failed leaders like AMP’s George Trumbull lumped in with equity gains made by people who created tremendous shareholder value during their tenures. Whatever the merits of their level of compensation, at least it was part of “growing the pie”.

But otherwise, the continued rise of management salaries is always justified by the notion of peer assessment – “someone else is getting this much and I’m as good or better than them” and/or “our company is bigger/more profitable/ harder to manage/more committed to excellence etc.”. By some accident of history, almost every board seems to rate their own CEO near “the top of the class” and takes the high end of the comparison range. In this way the managerial class has given itself a 15 per cent compound pay rise as a group and justified every individual decision by the unrigorous application of the notion of “pay for performance” (an otherwise worthwhile idea).

Some even suggest that the mandatory publication of senior management compensation is at fault as it encourages this sort of peer review. That reminds me of Americans who told me with a straight face that the problem of schoolyard violence was caused by there being too few metal detectors at school gates. And here I was thinking it might be something to do with fourteen-year-olds having access to Uzis!

Rather than trying to place management compensation under the cone of silence, we need to push boards to be more transparent and more rigorous concerning the basis on which “pay for performance” will in fact be paid. It needn’t need to be that difficult to ascertain when it’s deserved – in many cases, being able to deliver abnormal returns (that is, a combination of share price improvement and dividend payment that outperforms peer companies in the industry over a sustained period) would be a pretty good start. It sounds simple, but it’s damn hard to do. But for those management teams that can do so, bring on the performance bonuses. But not for the rest.

I have also heard many people say that if we didn’t keep paying these spiralling costs to senior management, we’d lose all the good ones to overseas. That is a bogus threat. Firstly, of the many highly qualified ex-pats I know, not one of them went over “for the money”. They left for opportunity – for bigger challenges; to play in the global A-grade. If we want our best people to stay, we need to develop globally competitive export companies, not try to pay ever more to people to run our domestic services oligopolies. If people want to be paid “global-level” compensation, they should build global-scale companies and deliver world-class performance to their shareholders. You can count on the fingers of one hand the Australian companies that have thus far managed to do that.

In fact, my discussion with many ex-pats and “re-pats” (ex-pats who’ve come home) tells me that one strong reason why people want to return to Australia is its unique culture, values and lifestyle. Australian egalitarianism is constantly mentioned in this regard. If we continue to follow a pattern of excessive compensation for mediocre performance at senior levels while expecting “restraint” from all other interested parties, we diminish that egalitarian spirit and reality.

Australia is no longer distinguished, for example, by an unusually low degree of income inequality or an unusually high level of home ownership. The most precious differentiator that we have to encourage the return of ex-pats – our egalitarian values – is diminished, not increased, by the spiralling disparity in compensation unrelated to performance.

Time for solutions

Thankfully Gideon Haigh is not alone. A casual reading of a range of commentators – from Stephen Mayne’s crikey.com.au to Mark Latham’s “insiders and outsiders” – reveals widespread questioning of the current operations of corporate Australia. And so there should be. Haigh’s essay is long on rigorous analysis and pointed criticism but short on solutions. While his suggestion that former middle managers could serve effectively on boards may well have some merit, it’s insufficient to address the magnitude of the imbalance we now have. Here are some initial thoughts on how to restore the balance.

Shareholder proxy services

Shareholders are not currently organised very well. That empowers the managerial class to indulge in new forms of excess. Internationally, organisations exist whose sole focus is to advise institutional shareholders on how to vote their rights at shareholding meetings, such as Institutional Shareholder Services in the US and PIRC in the UK. These can be voluntary associations or even private companies that charge subscription fees to the institutions.

The development of similar voices for Australian shareholders (or preferably even more powerful ones) is essential to counteract the passive acceptance that currently holds sway. That the chair of the Audit Committee of AMP could be reelected with more than 80 per cent of the vote after presiding over some of the most imprudent and value-destructive efforts of recent times demonstrates how farcical the current shareholder democracy structures really are.

The involvement of active and activist shareholders in notable areas of value destruction – such as excessive management compensation and dubious mergers & acquisitions activity – is long overdue. Perhaps the establishment of such advisory services would provide an informational and organisational counterpoint to the resources available to management. To state the obvious, however, the existence of such a service was clearly not enough to prevent the recent US outrages at Enron, WorldCom, Tyco and many others, but it would be a start.

There is an emerging set of international precedents for better and more active corporate governance and shareholder activism. The shareholders at GlaxoSmithKline in the UK, for example, revolted a couple of months ago and voted down their CEO’s pay package. It has gone “back to committee” for a rethink and not yet re-emerged, but the chairman acknowledged that the message was loud and clear. Tesco, the very strongly performing supermarket giant, also nearly lost approval for Terry Leahy and his management board’s compensation. The complaint focused on the two-year contracts which could “reward failure” if they were paid out. The compensation scheme passed by a whisker even though the company’s management had been extremely successful over the last ten years.

Corporate governance reforms

Corporate governance has to be fixed. Governance problems are endemic in the incestuous corporate board environments and poor regulatory and prudential environments that we currently have – look at HIH, Harris Scarfe, One. Tel, AMP and many others. Whether in terms of preventing fraud or merely in being competent, these and many other boards have failed.

Let’s get serious about it. The Australian Shareholders’ Association suggests no one should serve on more than five boards – only two if they are performing poorly – and a chair position counts for three.1 CEOs shouldn’t sit on each other’s boards. Executive and board compensation should be transparent and approved by shareholders, preferably in advance.

New forms of equity compensation

Having lived through the whole Silicon Valley thing, I’ve seen equity compensation work well and very badly. At its best, we’ve seen every employee be a shareholder in the company – in good times, most earned more from their shares than they did in wages, truly making them shareholders first and employees second. At its worst, poor performers made millions by being in the right place at the right time.

In Australia, through a perverse legislative environment, equity compensation is the preserve of the few. As a believer in the concept of aligning management’s interests (indeed all employees’ interests) and those of shareholders, I’d like to find a way for equity compensation to work. Current schemes, including their most evolved version in Silicon Valley, largely do not.

As Haigh pointed out, options are a one-way device – you win if the price goes up, but there is no penalty if the price goes down – and can encourage “swing for the fences” risks by management. Secondly, what happens to the price of shares at any given moment often has little to do with the inherent value of a company. Even very stable companies can often go through changes in share price of up to 50 per cent in a single year – even when the underlying business, and therefore its value, has changed little. Thirdly, as Haigh outlines in depth, the contribution of individual managers, if it could be measured at all, is often only seen years after the decisions they have made.

So let me outline a draft scheme that addresses some of these shortcomings:

  • Equity compensation could be paid directly in common stock, rather than as options. That way its cost is easily measured and incentives are aligned directly with those of shareholders – both up and down. It should, of course, be expensed at the time it is earned.
  • The amount of the equity compensation, like all compensation, should be determined by real relative performance measures, such as the “abnormal returns to shareholders” described above or measures based on the company’s relative financial performance to its peers on core metrics like return on invested capital – the important point being that the “performance” notion must be rigorous and must be comparative. It must be such that the worst performers in an industry actually don’t get any bonus at all (if indeed they keep their jobs) and only those who are unambiguously the best, on objective financial metrics, get the full amount.
  • These measurements must be taken over substantial periods – favouring a gradual increase in management compensation over long periods based on proven performance, rather than negotiated up-front compensation or compensation based on inaccurate metrics like short-term share price which may have nothing to do with management performance and are often consistent across an entire industry, sector or market rather than being measures of relative performance.
  • Management should be barred from selling more than a small proportion of stock – say up to one-third – in the year they earn it, and the remaining two-thirds should vest (that is, only be made available) two years after departure from the company. Such a measure would ensure that management works for the long-term value of the business. Of course, if the individual is fired for incompetence, this portion is retained by the company – a modest comfort to shareholders rather than the current practice of adding insult to injury by giving failed leaders massive payouts. (There would need to be safeguards to ensure such “firing” was not perverse or unfair.)

This type of structure appears to be gaining support. Microsoft has ceased granting options and instead now favours a form of restricted common stock. In the UK, Luc Vandervelde, the well-regarded Belgian CEO of retailer Marks &Spencer who turned the company around and has now stepped up to chairman, takes 100 per cent of his salary as a fixed number of shares per month. When he first joined the firm, sales and profits were sinking fast and the shareholders revolted and forced him to slash his package. Apparently this new idea was his own.

Corporate tax rebalancing

Companies and boards are ultimately free to pay their employees as they see fit (provided that they properly consult shareholders), but there should be some point at which excessive disparities no longer attract tax benefits.

Haigh cites such venerable business names as J. P. Morgan and Peter Drucker who both suggested the principle that no one earn more than twenty times that of their lowest-paid colleague. Heavens, in the current environment we could aspire to hold it at fifty times and still be found wanting. But at some multiple, whatever it is, it seems fair to draw the line – beyond this, managerial compensation ceases to be a deductible expense for the company’s taxation.

Government ultimately determines which expenses are tax-deductible and which are not; which calls on revenue have priority over the call of taxation and which do not. Hence the Fringe Benefits Tax. And so at a wider level it is neither conceptually inconsistent nor frighteningly radical to say that beyond a certain point the claim of management to compensation does not supercede the claim of taxation.

Of course, to rebut the accusation that this would increase corporate taxation by stealth, I’m quite happy for the average rate of corporate taxation to be adjusted downward so that the total tax take is the same. This fiscally neutral solution would reward good behaviour and discourage bad behaviour. Of course, without the other measures outlined above, it wouldn’t work very well because boards and senior management would probably just continue with the current level of continually rising excess and shareholders-be-damned. That’s why corporate governance reform is crucial.


These suggestions are by no means complete and some may prove to be ineffective on closer inspection. The important point is that this is the debate we should be having. How can we fairly split the economic fruits of our labours between capital, management and labour and indeed ensure that the pie is being “grown”, not just redistributed to the managerial class? What mechanisms can be used to ensure good governance, good management and maximum economic efficiency? Gideon Haigh has re-launched an important debate – let’s talk about solutions.


Evan Thornley is a co-founder and chair of the board of LookSmart Ltd, a publicly listed internet search company. He is a member of the board of the ALP’s Chifley Research Centre and, with Tracey Ellery, is proprietor of Pluto Press Australia. Prior to LookSmart, he worked for the international management consulting firm McKinsey & Company.

1. Position Paper on Multiple Directorships, Australian Shareholders’ Association, 28/6/02.


This correspondence discusses Quarterly Essay 10, Bad Company. To read the full essay, subscribe or buy the book.

This correspondence featured in Quarterly Essay 11, Whitefella Jump Up.


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