ANZ Chief Elliott admits the bank has become "too income-oriented"

Ken Henry asks about the state of capitalism – and agrees that it's not pretty

Ken Henry's monologue on the state of capitalism was one of the most philosophical moments of his sometimes difficult appearance before the Royal Commission on Banks.

Assistant Counselor Rowena Orr may have made a mistake in asking the President of National Australia Bank a fairly open question as to whether the bank was focusing too much on shareholders to the detriment of its clients.

Henry said the question was about the behavior of companies and what motivated them. things that boards have held responsible for conducting their business.

"It goes to the state of capitalism," he said.

"The capitalist model is that companies have no responsibility other than maximizing shareholder profits," he said.

"Many people who have been involved in this debate over the last 12 months have said that all the things boards should be accountable for are that they focus on maximizing profits for people. shareholders.

"Of course, some people will say," but that does not mean that you can abuse the customers because it could be in the interests of … short-term shareholder interests, but not in the long-term interest term of shareholders. & # 39;

"But even this approach sees customers as key tools, and they are seen as a way to secure shareholder profits rather than focus solely on the customer, but rather on the business."

He said that some saw clients as a means to a goal rather than an end in themselves.

& # 39; Monumental offset & # 39;

Rather than positioning the company to maximize shareholder returns, subject to the tolerance of customers and regulators, NAB's goal today was to maximize results for clients, subject to sustainability. financial. He described this "deep distinction" and "a monumental change."

The point of view of customers and shareholders as competing interests, in which the sole responsibility of a company is to maximize shareholder returns, is rather rude and outdated.

Most companies now recognize – and the fact of the Royal Bank Inquiry Commission points out – that they need a social license to operate. Indeed, they must deal decently and fairly with customers and suppliers, and comply with the law and regulations to survive.

However, Henry would have first-hand experience.

Some institutional shareholders have reacted adversely in recent years when companies have attempted to include non-financial and / or subjective measures in their compensation systems.

Last year's "first strike" against the Commonwealth Bank's compensation report and its intention to give the social metric a weighting equal to the financial metric in its variable pay assessments were mentioned by Orr.

Some fund managers, with business models to prioritize their own short-term performance, want a short-term alignment of shareholder and company interests; one on short-term returns for shareholders.

NAB itself recently restructured its executive compensation system, which provoked a mixed reaction from the market.

He grouped the short-term and long-term variable compensation of his executives into a single reward, 40% in cash at the end of the year and 60% in unvested shares after four years.

The measures that will determine and determine the size of the executive reward group and how it will be delivered include client results, risk and regulatory results, and financial metrics. The risk and compliance results are the "gateways" that the bank must release before any performance incentives are granted.

This will give the board a lot more discretion – and a lot more accountability and accountability for results.

"Too much is too much"

In parallel with the Bank Leadership Regime, in which the heads of various key banking functions are identified and held accountable – and accountable for their compliance performance, the incentives provided must better reflect individual performance on financial and financial issues. non-financial.

The nature of the pay structures that banks are trying to put in place in the context of the Royal Commission's broadcast of their dirty laundry and resistance to the inclusion of non-financial parameters, indicates that Henry's rumors about The state of capitalism is not just as anachronistic as it might seem at the beginning.

The proof of pudding, of course, lies in eating. Company executives tend to view variable compensation as a significant benefit. Despite what the Royal Commission announced about their behavior, bank executives have always tended to be given the bulk of their incentives.

Dr. Ken Henry, president of NAB, told the Royal Commission that the board of directors should have told management "too much, that is too much".

If NAB truly raises clients, risk and compliance results before total shareholder returns, its successes or failures must be measured as much by the benefits that they do not give – to managers and shareholders – as by those he is.

There will likely be (and is already) a short-term cost for refocusing on customers and compliance and abandoning the setting of total return for shareholders.

However, if the banks and other major financial institutions that have been saved by the royal commission do not make this change, there may not be a longer term future for their leaders or shareholders.