Some years ago the Australian Senate was considering the Bill which became the Company Law Review Act 1998.

The senators decided to engage in a bit of social engineering. They inserted a new section 300A into what is now the Corporations Act 2001 to govern listed companies.

In part it required that the directors' report for a financial year for a company must include details of the remuneration packages of each of the five company executives who received the highest packages for that year.

The then Government accepted the amendments so as not to hold up various other more important reforms which were scheduled to start on 1998-07-01.

ANNUAL REPORTS

The changes initiated by the senators might have sounded rather good on the surface and indeed they were welcomed in a number of quarters.

The new requirement quoted above is substantially unrelated to the prime purpose of annual reports of keeping shareholders informed in regard to investment aspects. Rather, the intention seemed to be that the compulsory disclosure of individual emoluments would force remuneration packages down.

The point here is not whether existing packages are appropriate or not - a legitimate matter for informed debate - but rather whether the new wording is a sensible way to go. This simplistic approach by those who do not like the status quo appears naive in the extreme.

REMUNERATION LEVELS

If the legislators thought that their innovation would lead to downward pressure on remuneration levels by making executives feel guilty about receiving excessive remuneration packages then they were sadly mistaken.

At one level, persons getting multi-million dollar rewards will readily tolerate a bit of embarrassment as a quid pro quo. Compulsory disclosure does not really shame them into asking for cuts in pay. On the contrary, high payments become a status symbol unrelated to their actual needs for money or generous benefits.

At another level, the theory that the shareholders will be so outraged that they will vote those involved out of office will not work either.

The bulk of the proxies at annual general meetings of listed companies are controlled by institutions. In practice their votes are exercised by persons who have a vested interest in maintaining generous compensation packages in the corporate world, because this creates useful precedents for their own deals.

In effect, the bulk of the voting power belongs not to the large number of small individual shareholders who have invested their own money but rather to a few members of the unofficial "club" of chief executive officers and senior managers.

The trend towards appointing chief executives to the boards of unrelated companies, while useful in many ways, also creates boardroom voices particularly sympathetic to higher remuneration levels for all chief executives.

NEGATIVE EFFECTS

The information published in the annual reports of companies made it that much easier for other companies to attract the executives away from the present employers because they knew exactly how much these executives were currently getting.

If anything, detailed disclosure leads to remuneration escalation all round. Any executives who are getting less than their peers in other comparable companies now have incontrovertible evidence which they can present to their own boards of directors to justify a case for a rise. Any executives who are getting more than their peers will just keep quiet. So the pressure will all be only one way - up.

Inevitably, the average figures for all relevant companies just keep going up all the time. Aiming to pay everyone in a group more than the average for that group leads to a mathematical impossibility. The concept of "comparative wage justice" is not confined to members of blue collar trade unions. In any event, in practice remuneration levels are governed by market forces.

Furthermore, the task of headhunters has been made that much easier. They now know exactly what they need to offer a potential recruit in order to tempt him away from his present employer. The flow-on effects from this pattern then actually also leads to higher remuneration packages all round.

PERFORMANCE

There is also a hidden cost to shareholders in the present practice. The disclosure requirements have encouraged boards to make large parts of senior executive remuneration packages based on performance.

This sounds pretty reasonable on the surface - investors are unlikely to begrudge high rewards if their own wealth from their share investments has gone up by significantly more than the yield for the index. However, such a formula also encourages greater risk taking and the adoption of strategies benefiting short term results at the expense of long term results.

Even if, miraculously, the social engineers had had their way and caused the rewards flowing to some individual tall poppies to fall then the outcome might not be as good as they had expected. This is because if the executives concerned are worth their salt then they might just decide to leave and take up attractive positions in other countries.

These days the world is more or less a single market for talented executives. Underpaying those working in Australia might cause the best ones to go overseas. The worst ones will stay, and the country will be the poorer for having induced a brain drain.