The Productivity Commission was asked to do a report on executive remuneration and has produced an excellent effort. You may disagree with its recommendations but as a guide to what has gone on Australian boardrooms over the past 20 years, it is very good. Every share owner in the country should read it.

The reason is that it’s not executives that come out of the report badly, it’s directors. The report is a serious indictment of Australia’s company directors. The story the PC tells is of cosy, complacent company directors who have been gulled by executives and American-style pay schemes into massively increasing the remuneration of executives for, apparently, minimal improvement in company performance.

In short, the PC has posed some serious questions of Australia’s boards, and they don’t appear to have any answers.

The issue the PC spends a lot of time coming to grips with is trying to explain why executive remuneration has exploded in the past two decades. It decided that the key influences were:

  • Australian companies have got bigger and more globalised and so has the labour market for executives
  • The move to incentive pay, which accounts for pretty much all the growth in executive remuneration at large companies
  • Boards have been too weak, conflicted and unskilled to properly oversee incentive pay.

The PC rejected the claim, which has been pushed by the private sector and some conservative commentators, that greater disclosure requirements have encouraged higher remuneration. It found no evidence to support it, only evidence that it played a role in adjusting relative remuneration between some executives. In fact, Australian evidence seems to suggest the rate of increase slowed slightly after the introduction of greater disclosure requirements.

The PC is also of the view that the US has inspired unhealthy trends in remuneration, even if Australia is a long way behind compared to the Americans, or for that matter the UK and some European countries. We imported those trends directly through the now well-established Australian tradition of hiring US executives who cost the earth but leave behind only trashed share prices, damaged corporate brands and angry shareholders.

The commission’s greatest concerns appear to be about boards — in particular, the tendency of directors to operate like a club rather than serve the interests of shareholders. Company directors, the PC found, tend to be old, male, already have or have had other directorships and are entrenched in directorships regardless of performance. That’s why the PC wants to see greater diversity among directors (including women, whose numbers remain scandalously low).

It’s also clear that they have simply not handled the move to incentive-based remuneration well. While there have been improvements as boards have become more familiar with incentive pay, boards tended to set performance hurdles that were too easily met, were too short-term or even simply didn’t work, meaning executives were generously paid despite poor performance.

In short, directors of Australia’s biggest companies have lacked the independence and willingness to do their jobs properly on remuneration, and weren’t quite sure how to do it even if they wanted to.

Not that that discouraged directors from remunerating themselves better. A survey earlier this year showed directors’ fees at the top 50 companies had increased by 130% over the past decade. That’s faster than the growth in CEO pay over the same period.

You can see why the PC thinks there’s a “club” approach to remuneration among boards and management.

The growth of “remuneration consultants” — a profession ideally suited for Douglas Adams’s Golgafrincham “B” Ark — appears if anything to have exacerbated the problem rather than improving it. While some consultants work only with boards, others are heavily conflicted because of links with management, and in some cases rely on management for other work, making their advice hopelessly self-interested.

The commission’s draft recommendations, then, are primarily targeted at fixing the problem of poor company director performance, giving shareholders more power and requiring greater transparency, less conflicts and greater independence so that directors start doing the job they’re supposed to be doing.

Criticism of the PC — and Bob Brown yesterday suggested people should be disgusted at the report — confuses outrage over high payments with a constructive analysis of the problem. The PC has identified board failure as they key problem, and has recommended ways to address that. Calls for caps on remuneration — which would never work anyway — are a direct interference in private property rights. If shareholders want to pay CEOs tens of millions, that’s their problem. The issue is whether shareholders have the tools to make sure boards do their jobs properly — and clearly the PC thinks they don’t.

If the community still has a problem with high levels of executive remuneration — and that may be justified — then the best means to address that is through taxation, not through arbitrary interference in the operations of companies.