This article is from the Australian Property Journal archive
Over the last few months PIR has been increasingly asked by its members, as well as a significant number of media representatives, what we think about the level of remuneration for the top echelon of LPT executives.
To the general public, at least, we have tended to answer in an Ancient Delphi-like fashion, worthy of Pythia’s enigmatic and furtive language. But to our valued members we would like to lay a clearer case.
PIR has collected remuneration data on the entire boards of directors of 24 LPTs (including the CEO or Trust Manager) that operated for the whole of FY2005 (CY05 for WDC), together with these LPTs’ unit/security price performance.
Typically, the CEO requires his/her Board of Directors’ sign-off before any material asset or corporate finance transaction can be implemented.
Therefore the CEO as well as the Board seem responsible in equal measure for the ultimate performance of the LPT.
In an ideal world, one should expect to see remuneration tied to performance. That is, the better the LPT has performed over a set period of time (in absolute terms), the higher the spoils going to the top-level management for that same period. And, equally important, the reverse should also be true: the worse the performance of an LPT, the lower the compensation for the people at the top.
This relationship would thus be more likely to motivate management, focusing minds in order to maximise shareholder wealth. Notwithstanding recent overseas examples where the presence of performance-linked incentives did not deter criminal behaviour among some high-profile company bosses, one would expect to see some link between the performance of LPTs and the levels of salaries and other benefits that the boards enjoyed.
And, in the event of that link being non-existent, one would like to believe that there are ‘activist’ investors out there trying to rectify this link in a particularly vocal and public manner.
Activist investors have sought to influence companies ever since the bursting of the South Sea Bubble led to calls for company directors to be hanged or tied in sacks and thrown alive into the Thames.
But although activism has taken on fresh vigour of late overseas, Australia has seen less action in this area. If a relationship does not exist between pay and performance (especially when performance is weak and pay is high), and no questioning of management is undertaken by its owners, in particular the large institutional investors who tend to hold the largest LPT stakes, then ordinary mum-and dad investors should be concerned.
They should be concerned for the lack of discipline markets are imposing on self-interested managers. Investors should also be concerned about the signals this behaviour – or lack thereof – gives to other ambitious managers contemplating launching LPTs.
Just as importantly, investors should be troubled that the large institutional investment houses, which more than likely manage a great deal of these investors’ superannuation ‘nest eggs’, may not be providing the required fiduciary level of care required under law.
Chart 1 depicts the overall results (the horizontal axis shows each LPT’s total return during the FY05 period, while the vertical axis plots the total pay package of the CEO and Board of each of these LPTs as a percentage of total assets – ideally pay would increase only with an increase in performance, i.e. we would like to expect that the dots would plot across a diagonal line, from bottom left to top right).
From a first view, there seems to be a rather steeply positive relationship between pay and performance, notwithstanding outliers such as MLE and MXG (for all ASX codes refer to page 4 of this Monitor).
That is to say, pay levels are very sensitive to returns achieved, although that relationship seems to break down at the extremes. For example, given the poor security price performance of MXG and MGR, their compensation levels seem too high, while given MLE’s stratospheric return it did not reward its board adequately relative to its peers (although many would baulk at any suggestion that Macquarie directors are underpaid).
The MXG and MGR boards of directors were rewarded with relatively similar levels of compensation (with respect to these LPTs’ assets under management) to those of IPG and CNP, even though IPG to a lesser, and CNP to a much greater extent, delivered very solid returns to their securityholders over FY05.
The other interesting thing to note is that boards of smaller LPTs tend to charge more than their large-LPT peers, something that is generally consistent with financial theory, in that larger LPTs reap more economies of scale than smaller ones, and some of those benefits materialise in the form of lower compensations (as a percentage of the asset base) for the boards of directors of these larger LPTs.
With that in mind, we have grouped the 24 LPTs according to their asset size. Chart 2 discloses the same scatter plot for LPTs with an average FY2005 asset base of less than $1 billion, Chart 3 shows the scatter plot for LPTs with an average FY2005 asset base of more than $1 billion but less than $4 billion, and Chart 4 illustrates the scatter plot for LPTs with an average FY2005 asset base of more than $4 billion.
Chart 2 indicates that, in general, the smallest LPTs boards’ remuneration packages were, generally speaking, justified by the total returns of the LPTs achieved over the FY2005 period. If anything, the THG board was not rewarded nearly enough for the Group’s solid performance, especially when compared with the compensation level of the JFM’s board. While MLE’s board reaped the benefits of a strong year, the senior managements’ pay was justified, in our opinion.
The dotted line represents the line of best fit.
Chart 3 depicts something that was not immediately apparent from Chart 1: mid-sized LPTs reward their boards with little reference to recent performance indicators. Although the three highest compensation packages are for CPA, MDT and MPR (these directors are paid by their respective banking parents, not the individual Trusts, and therefore tend to perform other, non-LPT related duties), massive discrepancies in performance between, say IOF and GSA were not adequate to differentiate rewards to managers.
This is an issue owners of LPTs should try to rectify (by, for example, introducing resolutions in Annual General Meetings calling for constitutions to be inserted with clauses providing stronger links between pay and performance), as it is both inefficient as well as demoralising to truly talented managers.
Boards of directors should not be guaranteed lucrative salaries; they should be made to earn them.
Chart 4 indicates similar results to those of Chart 3: that, in general, massive discrepancies in performance were not adequate to differentiate rewards to managers. If anything, there seems to be a slight negative relationship between pay and performance (excluding GAN, as per note in chart).
This has more to do with the extreme MXG and MGR data points, and the fact that we have grouped all LPTs with asset sizes above $4 billion into the same data plot, even though the biggest ones are far larger than that threshold (and therefore reap the economies of scale we brushed over before). Hence MXG’s and MGR’s boards earned salaries and benefits that were not warranted in our opinion, given their dismal total return performance.
Yet very little protest has arisen as a result. This, to us, indicates a corporate governance failure on behalf of major LPT owners, the professional property securities fund managers, in particular.
Maybe these fund managers would do well to follow Warren Buffet’s dictum of “Think like an owner”.
In conclusion, it appears as if the Board of Directors of MXG, MGR and, to a lesser extent, IPG have been rewarded too handsomely without any gruelling questioning from major investors.
Some stricter market discipline is warranted, in our opinion, although nothing would focus minds better than a credible threat of a hostile takeover. Which, coincidentally, is the kind of wild speculation IPG has recently been engulfed in… we feel it is high time!
By Peter Papadakos, REIT Analyst with Property Investment Research.*
Disclosure
PIR analysts hold or have recently held minor or unsubstantial interests in the following Listed Property Trusts: MXG, SGP, CNP, IPG, AEZCA & MDT
