By May the SA business cycle had scored a record-breaking 65 months of declining activity. And despite some desperate Ramaphoria wishful thinking, there are no persuasive signs of any recovery on the horizon. It is the longest bear phase in our history.
We all know the reasons: politics, corruption, a bloated civil service, frail economic growth, hikes in prices of "administered" goods such as electricity and water.
"Consumer spending remains under pressure, having to contend with increased living costs and high levels of unemployment," explained former retail star Pepkor as it unveiled a barely discernible 3.4% advance in profit for the six months to March.
Not only did it read off the "corporate excuse crib sheet", it tossed in a few extras: uncertainty around the 2019 elections, Eskom’s stage four load-shedding and, just to show even the gods were against it, there was the shift of Easter from March last year to April in 2019. No mention was made of the distractions caused by its reprobate 71% parent company, Steinhoff.
This came just as retail analysts were recovering from Massmart’s warning at its AGM that operating profit for the six months to June could be down a jaw-dropping 60%. A few days earlier the share price of the country’s second-largest food producer, Pioneer Foods, had dropped to a five-year low after it announced a 14% drop in headline earnings.
Pressure on consumers (the recession, near-record unemployment, high fuel prices and a VAT increase) had made it impossible to pass on the higher input costs.
Of course it wasn’t just the retailers suffering. Packaging group Nampak attributed its 9% drop in headline earnings in the six months to March to adverse macroeconomic conditions and currency volatility.
And, on the last day of May, Tongaat raised fears of a mini-me version of Steinhoff with grim talk of "past practices" that led to "financial statements that did not reflect Tongaat Hulett’s underlying business performance accurately". It conjured up fears of its 2018 annual report being revised, à la Steinhoff, with every page stamped "information can no longer be relied on" in embarrassing red letters.
Those familiar with cautious legalese might have detected similarities with Sasol’s update on the bottomless pit that is its Lake Charles Chemicals Project (LCCP).
It seems the previous management understated the estimated costs by over $1bn. In part, it now turns out, because of "weaknesses in the project’s integrated controls".
The list of train wrecks goes on and on. It includes Aspen, MTN, Hulamin, Woolworths, Rebosis, Resilient, Tiger Brands, EOH, Trencor and of course Steinhoff — most of which have destroyed shareholder value due to poor management decisions or behaviour that falls way short of acceptable governance.
Now, while it is reasonable to blame the record-breaking tough trading environment for weak operational performance, it’s a stretch to blame Jacob Zuma or load-shedding for what happened at Steinhoff. Or to blame high electricity prices for Resilient’s overstated balance sheet, or global sugar prices for Tongaat’s accounting, which created R4.5bn of value that can’t be found.
In all of this turmoil, one thing has remained distressingly constant — generous levels of executive pay.
Whatever happens to a listed company, it seems boardroom pay is the last thing to be sacrificed. Our top executives are being paid for perfection while delivering, in general, a healthy dollop of mediocrity.
What goes up, only goes up
In its latest compensation report, released in October 2018, Deloitte says that executive pay has been resilient, despite varying company or sector performance.
"Though trends in shareholder value and company performance have been largely dictated by economic and market conditions, this is not the case in executive pay, which has been resilient over time and has essentially doubled over the [previous] six/seven-year [years]," it says.
As an indication of how skewed this is, Deloitte says there were only a few instances when the CEO or CFO was not paid a bonus. "Many an executive can expect to earn at least one time and as much as three times their base salary in performance variable pay, often where there is no discernible link to company performance or shareholder value."
And while a CEO is meant to also get "variable pay" based on performance, it really seems to be performance-contingent pay "accruing under most circumstances other than the worst case of underperformance".
Woolworths’ shareholders will take little comfort from knowing that their executive team is one of the very few that made it into that latter category.
After reporting the worst results in 10 years, Woolworths CEO Ian Moir and his colleagues had to forgo their short-term incentives in 2017. A hefty R7bn write-down on its Australian acquisition and a 13% drop in headline earnings the next year meant no performance bonuses in 2018 either.
But this is the exception. As Deloitte points out, it’s more common for executives to chalk up a bonus, no matter what.
Take Lonmin’s executives led by Ben Magara, who oversaw an epic-scale destruction of shareholder value, yet who will collect a R130m bonus when the Sibanye-Stillwater acquisition is completed.
Or Tongaat. By the time he took "early retirement" in October 2018, the sugar company’s CEO, Peter Staude, had bagged R176.4m in remuneration since 2008. His financial director, Murray Munro, also didn’t do too badly, collecting R97.6m.
And as usual, the largesse wasn’t limited to the executives. During her years as an independent nonexecutive director and chair of Tongaat’s audit and compliance committee, Jenitha John took home R7m in directors fees before jumping ship last week.
Took home R448m in salaries and bonuses during the decade in which, unbeknown to all but seven others, he was leading Steinhoff towards its implosion
Her decision to quit was due "to other work commitments and Tongaat’s increased demands on [her] time, given the current business challenges", said John, who took up a position on Nampak’s board in 2017, and is FirstRand’s chief audit executive.
Consider too that Steinhoff’s former CEO, Markus Jooste, took home R448m in salaries and bonuses during the decade in which, unbeknown to all but seven others, he was leading the retailer towards its implosion in December 2017. A decade in which Steinhoff created R106bn in "fictitious transactions".
As for the possibility of clawing back bonuses that proved to be, at the very least, undeserved, don’t hold your breath.
In 2015, building materials group Dawn made history when its two executive directors agreed to pay back some of their bonuses — a feat not yet repeated. The Steinhoff board says it is going after Jooste’s irregularly paid, seemingly by himself, bonuses.
Shareholder activist Chris Logan believes the Tongaat board should be trying to get something back from Staude too. But you’d have to be a particularly brave soul to bet on it happening — at Steinhoff or Tongaat.
The FM’s research appears to back up Deloitte’s hypothesis. In their most recent financial year, the CEOs of the largest 40 JSE companies were paid R2.1bn in total.
This was calculated using the "single figure remuneration" in those 40 annual reports, which includes the value of bonuses and long-term share incentives now.
However, it means that each of those companies forked out, on average, R52m for their CEO. On average, those CEOs had a 24% increase in their total remuneration last year, exceeding the average growth in profits for those companies. And this, while the share prices of only half those top 40 companies grew during the year, and the rest fell.
The best paid, predictably, were those CEOs sitting in London or overseas.
For example, Anglo American CEO Mark Cutifani got R268m — a 105% jump from the prior year, as his bonuses and incentives worked out to R271m. But at least his company grew its profit and its stock rose.
This wasn’t so with British American Tobacco (BAT), where CEO Nicandro Durante got the equivalent of R161.6m, just 13% less than he’d got the year before, even though BAT’s pretax profit plunged 71% and its share price nearly halved. Here again, the CEO lost far less than his shareholders.
There were a couple of other outliers too — both good and bad.
Switzerland-based Glencore CEO Ivan Glasenberg was paid far less than his peers, getting the equivalent of just R21.7m. Though Glasenberg does own 8.8% of Glencore, since May 2011 he has "waived any entitlement to any increase in salary" and only takes benefits "provided to all employees at the company’s head office in Baar".
Equally, Remgro CEO Jannie Durand was also paid below the average, taking home R13.9m last year, despite his company’s 424% increase in pretax profit. Though Remgro wanted to give him a 7% increase, Durand "declined the increase and requested that the equivalent increase amount should be included in the Remgro corporate social investment (CSI) budget for local CSI initiatives".
On the less commendable side, Sasol’s co-CEO Steve Cornell got a 24% increase in remuneration, to R46.2m — despite the Lake Charles disaster, and the petrochemical company’s 47% fall in pretax profit. And Gold Fields CEO Nick Holland took home R39.7m — 45% more than the year before, even though his company reported a $348m net loss, and its share price slid 8.8%.
A tenuous link
But things may be even worse than Deloitte suggested.
What if, despite voluminous remuneration reports, replete with pseudo-scientific metrics, remuneration is just way off track philosophically when it comes to aligning pay with corporate performance?
A report released by two academics at Lancaster University Management School in 2017 concluded that the link between CEO pay and any measure of fundamental value creation was negligible at best.
The Lancaster study covered 12 years, from 2003-2015, during which total pay for the median CEO increased by 82% in real terms. In sharp contrast, the median FTSE 350 company generated little in the way of economic growth.
"While EPS (earnings per share) growth and TSR (total shareholder return) are the dominant means of incentivising and rewarding CEOs, these metrics correlate (very) poorly with theoretically more robust measures of value creation that relate performance to the cost of capital," the academics found.
A year later an MBA student at Stellenbosch University, Stephanus du Plessis, came to a similar conclusion after studying CEO pay and financial performance at JSE-listed consumer sector companies between 2002 and 2012.
While there was a relationship between executive remuneration and traditional performance measures such as return on assets (RoA) and return on equity (RoE), there wasn’t much connection with more effective measurements of performance such as economic value added (EVA) or market value added (MVA).
Du Plessis said that even though EPS is an inferior metric, it is the most widely used financial performance measure, mainly because it is simple to calculate, easily understood and executives are congratulated when the number grows.
As Du Plessis wrote, EPS, RoA and RoE are all inferior measurements as they are prone to manipulation, are short term, and focus on past financial performance rather than the creation of future value.
After churning through a decade’s worth of figures for 33 companies, here’s Du Plessis’s finding: "It can be concluded with 95% confidence that there is no statistically significant correlation between CEO total annual remuneration, including share options exercised and both the short-term and long-term company financial performance for JSE-listed consumer goods and services subsector companies."
But his conclusion, that pay and performance aren’t aligned, might explain why the generous payments to executives isn’t leading to better long-term performance.
A similar study of mining companies from 2002 to 2016 by fellow MBA student Francois Minnaar was even more damning of pay practices in the mining sector.
Minnaar agreed with Du Plessis that measures such as EPS and HEPS were backward-looking and easy to manipulate. And his research showed starkly that total guaranteed pay (TGP) for mining executives rose, even while company performance fell.
"Shareholders should demand accountability from remuneration committees on why CEO remuneration keeps rising while profitability and shareholder value are destroyed," he wrote.
Minnaar said the disconnect between rising pay and falling profitability suggested there are considerable "agency costs" involved in the setting of CEO remuneration.
The problem of agency costs was the subject of an "investment insight" by Allan Gray analyst Pieter Koornhof recently.
The problem, says Koornhof, dates back to the world’s first publicly traded company, the Dutch East India Company (DEIC), which was the first time the public could buy shares in a company managed by someone else. "This separation of ownership from management was crucial, as it enabled entrepreneurs to raise capital from the public to fund new ventures and technological innovations," he says.
But, in a development eerily prescient of Steinhoff 408 years later, the DEIC was hit by a governance crisis in 1609 when its executives raided the company’s coffers to enrich themselves, at the expense of shareholders. The first shareholder revolt took place in 1622, says Koornhof, when it emerged that executives had been cooking the books, so shareholders demanded a proper financial audit. Think December 2017, PwC and Steinhoff.
Koornhof says the upheaval at DEIC nearly 400 years ago was caused by what economists call the "principal agent" problem.
"In the context of public companies, the root cause of the problem is that the incentives of executives who manage the company day-to-day are not always aligned with the long-term interests of shareholders, the owners of the company," he says.
Which is where executive remuneration comes in, and why enormous effort is devoted to getting it right. "In theory, executive remuneration policies should nudge executives to act in shareholders’ long-term best interests," says Koornhof.
Many do, but others simply game the system for their own private gain.
If Du Plessis and his academic colleagues are right, then gaming is inevitable because the executives are on the wrong incentive diet.
Downside of dissonance
Now consider some of the recent poor results, in light of these incentives.
One of the people not surprised by Massmart’s recent shocking results was David Holland, an adjunct professor at the UCT Graduate School of Business.
From 2010 to 2017, Massmart’s growth in invested capital was 203%, yet over that time, sales grew 98% and trading profit increased just 40%. Massmart’s return on capital kept dropping too, as its trading margin fell to just 2.9%, from 4% in 2015.
Halting, and then reversing, that decline will be the new CEO Mitchell Slape’s first task, if Walmart is to have any hope of seeing any return on the hefty R148 a share it paid in 2012 for its 50% stake.
Because the executives weren’t rewarded based on the right metrics, like judging them on how much of a return they made on the operating capital provided by all funders, things slipped. This metric, which Holland calls a company’s "economic profit", is a similar measurement to EVA.
It’s a similar story at Aspen. Holland says the warning signs were there at Aspen for years, even as it continued to enjoy a top rating among investors. He says that while its return on invested capital was still attractive as recently as 2017, it had been falling since 2011 as the company piled on more debt to fund its acquisitions. Its return is now below the cost of capital.
"In a nutshell, the company has been paying too much to grow revenue and earnings," says the professor. But, in a world where revenue and earnings are the key metrics to determine pay, this might be inevitable.
As for Tongaat, Holland knew it was a disaster long ago. In a report he wrote a year ago, Holland said the sugar group hadn’t been generating enough operating profit to meet its capital expenses, so its economic profit had been negative for seven years.
"The cumulative value destruction over the past seven years is R8.2bn," said Holland in June 2018, while Staude was still in the driving seat contemplating "early retirement".
But the focus on earnings means boards will support investments and acquisitions that might make no financial sense.
This sentiment (along with political corruption) has influenced executives to rush to build up an asset base outside SA.
"Some [of these foreign deals] work, most don’t," says Holland. He reels off a list of disasters that includes Tiger Brands in Nigeria, Brait’s investment in New Look in the UK, the Woolworths purchase of David Jones in Australia, and Famous Brands’ punt on Gourmet Burger Kitchen in the UK.
Either way, by June 2019, gaming the system seemed the default option for so many executives that a jaded observer might fear a systemic collapse is imminent.
Corporate governance codes, which sprang up in the 1990s, were intended to minimise all that could go wrong. But perhaps the best that can be said about this thriving "governance industry" is that things might have been even worse without it.
The downside is the emergence of "remuneration consultants" who are paid handsomely to advise "remuneration committees" on why they need to increase pay.
In fact, the "principal agent problem" for a listed entity in the 21st century is two-fold. First, you have executives managing companies on a day-to-day basis rewarded incorrectly; second, you have large asset managers (Allan Gray, Coronation, Old Mutual, Sanlam, Investec are the biggest of about 400 managers) managing the shareholder role on a day-to-day basis, on behalf of tens of millions of private savers and investors.
What could go wrong, you ask.
Well, it’s not just a matter of trusting the integrity of professional strangers. For the beneficial shareholder, the company must be viable enough to generate sufficient returns so everyone in a long chain of advisers can get a slice. But what does go wrong is that when times are tough — such as the past three or four years — the beneficial shareholders at the end of this long chain get hardly a whiff of return on their investment.
Earlier this year the UK’s High Pay Centre released research into voting patterns at FTSE 100 companies between 2014 and 2018, looking at whether giving shareholders a vote on pay packages has made a difference. Despite the impression created by the occasional high-profile clash, the research found minimal engagement by shareholders.
"Shareholder say on pay has failed," said author Ashley Walsh, who found the lack of engagement difficult to reconcile with the absence of a link between very high pay and company performance or the widespread public disapproval of these packages.
Ashley flagged a possible subconscious bias by investment managers in favour of highly paid executives, on the basis that these investment managers themselves tend to benefit from a culture of very high pay.
Disengagement and fragmentation — often across the globe — of the shareholder base, was also a factor in the depressing results, as it made it difficult to co-ordinate action.
(While voting on remuneration at SA companies appears to be more engaged, the fact they are nonbinding votes means they are less threatening to vested interests.)
But perhaps the most chilling reason given in the UK report was risk aversion — seeking to avoid a CEO threatening to quit if his remuneration package was rejected.
It’s an old canard. And in SA, this goes hand-in-glove with the "skills-shortage excuse" used to defend some of the JSE’s poorest-performing CEOs and their somnolent boards.
A straw-man argument
"The skills shortage excuse is bullshit," says one former CEO. He suggests the search for talent should be removed from the control of headhunters, who typically churn through the same small pool of talent.
While poor education and a historic lack of opportunity for the majority of the population gives the excuse some credibility in SA, the skills scare has been used for decades across the globe to justify teeteringly high pay levels.
Deborah Hargreaves, a founder and director of the UK’s High Pay Centre, says this argument falls down on its own economic terms and represents market failure on an epic scale. "In any normal market of supply and demand, if the supply of something is scarce, the price rises temporarily but there is usually a move to increase supply, which brings the price back into equilibrium," she says.
Hargreaves speculates there are plenty of people who could develop the skills to be business leaders — they’re just not given the opportunity. Instead, headhunters use the "usual suspects" to fill the jobs, arguing that they need tried and tested individuals.
It’s also odd, given the tide of business schools established in the past 30 years.
However, Linda de Beer, who has been a director of companies including insurance group MMI, fertiliser company Omnia and Aspen, says the skills-shortage argument is compelling. It’s why smaller companies have to pay in line with the big players, who are happy to poach their proven talent.
"There’s a strong view that in bad times you can’t afford to lose people, so you pay top dollar despite results and in good times it’s easier to afford," says De Beer.
Deloitte’s Leslie Yuill agrees that a rethink on remuneration is probably necessary but is unclear as to what the perfect solution would be. Anyway, how would you persuade a remuneration committee to do anything different from its peers?
"It is important that any ‘rethink’ carefully distinguishes between a poor result, which may be due to structural reasons beyond the control of management, and a crisis which was caused by incompetence and/or dishonesty," says Yuill. New regulations aren’t the answer, he says.
JSE CEO Nicky Newton-King, who urged parliamentarians during a Steinhoff hearing last year to avoid further regulation, has a more upbeat perspective. She reckons boards are no longer shying away from tough disclosures.
But Newton-King also urges a rethink on remuneration. "Executives can’t win when everyone else is losing; boards must be braver," she says.
While she’s right that new regulations might not be the answer, there is growing support that SA should have a binding vote on pay at company AGMs, in which any vote below 50% would result in the packages being rejected. Right now, it is just an "advisory vote" that companies can — and have — often ignored.
What it means: CEOs of the JSE’s top 40 companies earned, on average, R52m last year — a 24% rise on the year before
— What it means
The most ironic suggestion, bordering on bizarre when it comes from well-resourced players, is that we need more activists like Theo Botha, Chris Logan, Albie Cilliers and the NGO-backed Active Shareholder, all of whom operate on wafer-thin resources.
While they may not be able to stop egregious governance contraventions, they do ensure such contraventions get media coverage, which tends to discourage future transgressions.
Active’s Mike Martin says much more can be done by the big asset managers — such as voting against reappointing directors on remuneration committees.
A sad indictment of developments over the past 20 years is that neither the Public Investment Corp (PIC) nor the trade union movement, both of which own large stakes in JSE-listed companies, have acted to compel restraint. The PIC, if anything, even accommodated some of the worst excesses.
Still, things may change. Cosatu’s parliamentary co-ordinator Matthew Parks tells the FM that the unions are now pushing for a pay cap to impose a maximum amount that an executive could get paid.
"It’s unacceptable that companies are being run into the ground at huge cost to employment, and yet the executives are being paid so much more than the president of the country," he says.
Perhaps, but there is no doubt that being a CEO is a remarkably challenging job. The excellent CEOs, who grow the business, create jobs and don’t just chase short-term earnings, deserve to be very well paid; the others don’t.
When that happens, it’s hard to avoid calling it what it is: corporate capture.
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