What should chief executives be paid bonuses for?

It's a question investors are considering as they ponder the A$12.3 million ($12.9m) Commonwealth Bank chief executive Ian Narev will pocket from pay and bonuses this year.

Narev secured a 50 per cent pay rise after delivering a record A$9.45 billion profit for the bank.

But what has got investors upset is next year's bonus.


CBA, which also owns ASB Bank, is changing its bonus structure so that half of it will comprise non-financial targets, including 25 per cent for meeting a "diversity, inclusion, sustainability and culture target".

Narev already receives 25 per cent of his bonus for "customer satisfaction".

CBA is the latest company to introduce qualitative, nonfinancial performance hurdles into its executive remuneration structures. This is concerning for investors, because these "soft" targets are harder to measure and hence easier to meet.

"Our bigger concern is that the CBA Board has changed its bonus structure to make it easier for Mr Narev and his successors to continue to receive large payouts in the future," said Australian Shareholders Association director Allan Goldin.

"Whilst the changes reflect important sentiments in reality, where hurdles are based on qualitative measures which we see quite often in the short term incentives, there is so much flexibility in interpretation that payment of the bonus will effectively be up to the board to decide."

The Australian Shareholders' Association says more companies are introducing these sort of "soft" bonus measures.

Woolworths now include safety in its bonus calculations. Telstra is introducing bonuses based on its Net Promoter Score and a new Service Experience Index (Net Promoter Score -NPS- is a management tool that can be used to gauge the loyalty of a company's customers). Insurer IAG is also relying on NPS in the calculation of its bonuses.

Already one company has faced the wrath of shareholders.

Gas and electricity retailer AGL handed its chief executive Andrew Vesey nearly A$7m in pay and bonuses. Investors are concerned that much of the bonuses was for things such as "team effectiveness", "individual effectiveness" and "strategic effectiveness".

Even the portion that was linked to actual profit has got investors upset.

AGL made a statutory net loss of more than A$400m in 2016, however, it had an underlying profit of around A$700m.

A company's underlying profit strips out unusual and one-off items such as the write down in the value of a company's assets. It can be a useful indication of performance, but shareholders earn dividends from net profits and that is what should be used to calculate executive bonuses.

Guess which figure was used to calculate Vesey's bonus?

At the company's annual meeting last Wednesday, shareholders holding more than a third of the company's shares voted against the company's remuneration report.

That vote earned AGL what is known as a "strike". Should 25 per cent or more of shares vote against the company's remuneration report next year, the second strike will automatically trigger a board spill, where all board members will have to stand for re-election.

It's a rule designed to give shareholders some power over companies which pay their executives too much.

It looks as if the two-strike mechanism will get a good workout in the current AGM season.

Even before the changes to CBA's current bonus system come into effect, this year's bonus to Narev is also attracting attention.

More than half of the pay which Narev took home came from the vesting of prior long-term incentive awards.

Investors are concerned that Narev, a Kiwi who attended Auckland Grammar School and the University of Auckland, earned the bonus despite the bank failing to meet its Total Shareholder Return target. TSR is made up of a stock's capital gains and dividends.

For its part, CBA argues its remuneration structures reflect the views of a wide range of stakeholders, including employees, partners, customers and the general community.

No one is arguing that CBA shouldn't have a diverse workforce and an inclusive culture or that it shouldn't pursue sustainability. These should be core ambitions for CBA and any other company. What is questionable is whether executives should be paid a bonus for pursuing and meeting these targets.

The executives and the board should be primarily answerable to the owners of the company, the shareholders, and they should be paid according to how those owners benefit.

CBA acknowledges this in a roundabout sort of way when it argues that a strong performance in diversity and inclusion will lead to "strong and sustainable shareholder outcomes" in the future, according to media reports.

This is certainly true. Many studies show that companies that pursue a diverse workforce and include sustainability in its goals generally perform better than those which don't.

But CBA and others should wait until those benefits flow through to the bottom line and investors receive the benefits along with the rest of society. Then they can pay their executives a bonus.