License article

Scorch of blowtorch on the big cash splash

WHEN the directors of Macmahon Holdings take the stage at the Pan Pacific Hotel in Perth on November 9, they will be bracing themselves for a first strike on executive pay. If its largest shareholder, Leighton, votes its 19.4 per cent shareholding in favour of the remuneration report, directors might dodge a bullet.

But given the number of write-downs and profit downgrades pouring out of this sector in the past few years, the penny is starting to drop that industry-wide reform is required - now.

Put simply, the contract industry is notorious for over-rewarding its executives and structuring remuneration packages to the point where most have been detrimental to shareholders. They have also been grossly overweighted towards cash.

A report titled Executive Pay in the Contracting Sector, Wrong Way, Go Back, by proxy advisory group Ownership Matters, argues that Leighton led the pack in weighting pay towards cash. It says the sector has historically paid its chief executives high due to the ''Wal King effect'', which raised the benchmark for other bosses, including those of Macmahon, UGL and others.

It says in the 2012 financial year, for example, cash pay for key management personnel (senior executives and directors) was above 5 per cent of operating cash flow at every contractor other than Downer EDI and Monadelphous. At Macmahon it was 12.3 per cent, at UGL it was 8.3 per cent, at Transfield Services it was 6.1 per cent, and at Leighton it was more than 8 per cent during the reporting period available.

The upshot was at each of these companies, with the exception of Leighton (whose year-end changed and hence 2012 is the six months to December 2011), key management personnel cash pay was above 1 per cent of operating cash flow.


The report also reveals that statutory disclosures on a cash basis can also understate the impact of executive pay arrangements on cash flow. For instance, UGL boss Richard Leupen received an additional benefit of about $757,000 in fully franked dividends on unvested shares and UGL's operating cash flow excluded the cash expense of acquiring $4.3 million in shares for Leupen in August 2011. ''UGL's operating cash flow in 2012 would have been just $93 million rather than the reported $111 million had the $18 million the company spent on acquiring shares for employee incentive schemes in the year been recorded in operating and not financing cash flow (the key management personnel [KMP] cash to operating cash flow ratio would have been 9.9 per cent on this basis - and the KMP cash pay figure excludes the cash cost of acquiring shares on their behalf),'' the report says.

UGL isn't alone and investors have had enough. The feeling is that Macmahon has put a line in the sand in terms of putting the sector back in kilter over how it remunerates its executives. (Some have already tackled this).

But the key issue to be addressed is that pay structures in the sector are dominated by single-year profit measures. This is an issue for contractors, given the treatment of revenue recognition before a project is completed.

In the case of Macmahon, the blowtorch is on the board as it tries to do a balancing act in keeping investors on side and coming to a remuneration package that gives proper incentives to new chief executive Ross Carroll. The talk is that his salary will be far more modest than his predecessor's and have various hooks in it to appease angry investors.

There is also a lot of heat on Vyril Vella, chairman of Macmahon's remuneration committee and also Leighton's representative on the Macmahon board. Leighton holds almost 20 per cent of Macmahon stock, which gives it a lot of clout when it comes to the message it can send to the board in terms of pay.

Like many contractors, the optics of Macmahon's remuneration package isn't good and Leighton has gone a long way to fix its own, after taking a lot of flak and suffering write-downs, losses and an equity raising in the past two years.

Macmahon's share price has almost halved in the past few weeks after it shocked the market with a massive write-down and 50 per cent downgrade of 2013 profit forecasts, weeks after forecasting a 20 per cent profit increase for 2013.

Everyone can make a mistake but what made this particularly outrageous was the generosity of the remuneration packages awarded to executives in 2012.

According to Ownership Matters, the Macmahon board granted former boss Nick Bowen and his executive team generous cash bonuses of $2.57 million, more than half of which was based on targets linked to the 2012 profit. No part of the bonus was deferred. It says the strong ''apparent'' performance of Macmahon prior to the September 2012 downgrade also saw 2.684 million zero exercise price options vest to Bowen based on the company's total shareholder return over the three years to July 2012. After the downgrade, Macmahon's share fell 39 per cent on the first day of trading. These vested rights were $832,000 on September 20, following the downgrade.

The report suggests adoption of the following measures: impose holding locks of up to one year with clawback provisions on vested long-term incentives; require executives to have some skin in the game by retaining vested equity rather than selling it; reduce the importance of annual cash bonuses and avoid incentives linked to the winning of contracts or single year-profit targets. It is hard to argue with.