Macquarie Group: Heads I Win, Tails You Lose

Confirmation that Nicholas Moore’s $12 million pay cheque has made him among the highest paid CEOs in corporate Australia risks giving rise to a renewed backlash against what many consider to be excessive CEO pay, particularly for CEOs that preside over financial institutions that benefited from taxpayer funded support during the financial crisis.

This is not to deny the fact that Macquarie Group has given its shareholders plenty to cheer about in recent times.  In the three years to June, Macquarie delivered total shareholder returns of over 125%, among the top 10 in the large cap universe.

But taxpayers and Macquarie shareholders are entitled to ask whether Nicholas Moore and his senior executive team are really worth it.  After all, Macquarie shareholders would have been better off invested in the broader market over the past seven years.  Since its pre-GFC peak in 2007, Macquarie has posted a total shareholder return of close to zero, well below the 10% delivered by the broader market. 

Macquarie shareholders are also entitled to feel let down by some creative and astute lowering of hurdle rates associated with the company’s performance based remuneration.  Two important changes made in 2013 were a reduction in the EPS growth target range to 7.5%-12% from 9%-13% and a change in the peer group of companies for the ROE hurdle, which excluded the Australian major banks.  The new peer group was composed entirely of US and European investment banks, which have materially lower ROEs than the Australian majors.

According to Thomson Reuters, Macquarie Group posted an ROE of around 10% in its most recent full year result, which looks like a stellar outcome when compared to the median of 4.5% for the new comparator group but is broadly in line with the median of 8.5% of the old peer group.  The changes to the hurdle rates effectively have added millions to the pay packets of Nicholas Moore and his senior executive team in the past year.

Shareholders should also question the relevance of comparing Macquarie’s ROE to a peer group of global investment banks when funds management has emerged as the key driver of the group’s profit, generating a pre-tax profit of over $1 billion in their latest full year result, well above the combined profit of $830 million delivered by the Securities and FICC divisions.  Moreover, the market is increasingly pricing the stock as an asset manager and less as an investment bank.

The annuity style income that the Funds group offers is a welcome development for the company at a time when investors have an insatiable appetite for income, and is a credit to the management’s foresight years ago to diversify its traditional heavy reliance on the cyclical and capital hungry investment banking businesses.

Nonetheless, the new dominance of funds management within the group represents a practical problem for the purposes of setting CEO pay, because Macquarie’s ROE falls well short of that achieved by other listed global asset managers.  Macquarie’s ROE of 10% is well below the median of 17% among the largest 20 global asset management firms.  The likes of BlackRock, T Rowe Price, Invesco and State Street posted ROEs above Macquarie in their most recent full year results.  Would you really expect senior management at Macquarie to adopt a new peer group of companies for its hurdle rates that delivers consistently higher ROEs? 

This also raises an important philosophical question about whether Macquarie Funds is better off without being burdened by the low ROE, low multiple investment banking divisions.  It is far from clear whether housing the distinct businesses of investment banking and asset management under the same roof generates any synergy benefits. 

As far as taxpayers go, there is little doubt that the Rudd Government’s decision to introduce formal taxpayer funded depositor protection in the form of the Financial Claims Scheme in 2008 helped to restore confidence in Australia’s financial system and effectively safeguard the likes of Macquarie Group and other financial institutions.  But taxpayers' patience is rightly wearing thin when it comes to the asymmetric payoff that Macquarie offers of heads I win, tails you lose.

Despite Basel III rolling out tougher global capital requirements, Macquarie still holds less than $10 of equity capital for every $100 of assets.  In contrast, Australian non-bank companies typically hold around $50 for every $100 of assets.  This woefully inadequate level of bank capital arises due to taxpayer funded depositor protection.

At a time when the Murray Inquiry is putting a microscope over the governance at financial institutions, the revelation that senior Macquarie executives are richly rewarding themselves warrants greater scrutiny by shareholders, taxpayers and policy makers alike. 

Macquarie should think seriously about the longer run impact on its reputational risk if senior executives continue to enjoy the spoils in good times but expect taxpayers to foot the bill for its excessive risk taking in bad times.  That does not represent a sustainable social pact.