BHP Billiton presents its formula for executive pay

July 2003

Few global companies have as tough a job to get their senior executive remun eration packages as BHP Billiton. It is the world's largest diversified natural resources company, valued at just over $36 billion. Its mines and petroleum operations are divided almost three ways between, Australia, the Americas and South Africa. So, its operations are in highly stable nations and also in countries where there is some perceived risk.

Its big customers are the heavy industries of the United States, Europe and Japan, markets where there is tough competition from other resources giants like Rio Tinto, Anglo American, Alcoa and CVRD.

And with a position in most strategic metals and petroleum, its executives have to negotiate and maintain good relations with a motley assortment of governments and trade unions. As if all this is not enough, BHP Billiton is itself the product of a complex merger - between Billiton and Melbourne-based BHP, then one of Australia's largest companies. Getting pay packages right between companies that were once in competition and are separated by 18,000 kilometres was a huge task in itself.

It was, as Ian Fraser, Vice President of Human resources, put it "quite a challenge", especially as BHP Billiton, with a wide shareholder base, is now listed on both the Australian and London Stock Exchanges which have strict, but sometimes different, corporate governance requirements.

To its credit, the company has tackled the task with energy and imagination. It was essential says Mr Fraser for BHP Billiton to "pay for performance rather than for failure and to link rewards to executives to creation of value for shareholders".

Another mantra was to limit severance arrangements "to pre-established contractual arrangements, which do not permit the company to make any unjustified payments in the event of non-performance".

The system that BHP Billiton has come up with is a package whereby 40% is base salary and 60% is what Mr Fraser calls "risk pay". Base salary yardsticks are the scope of the job, experience and market comparisons.

The risk pay construct is complex but worthy of examination because it strikes at the heart of corporate governance issues. Executives have to overcome a series of performance hurdles, most of them derived from predefined value drivers.

These are set out in the table, and include managing the asset base, customer satisfaction, project selection, capital management and innovation. As can be seen from the table, the value drivers depend considerably on creative thinking and commercial judgments, as well as more fundamental management skills.

The table then lists performance measures, which, it says, perhaps optimistically, are how it feels the market should judge the company. Certainly goals like cutting operating costs by 2% a year over three years, producing a return on capital of 15% and attaining high "A" credit ratings are what current markets expect.

Translating these into financial, operational and personal hurdles is relatively easy, and an executive can target his or her annual bonus as against a hurdle scorecard issued to each senior manager.

But only half of the annual bonus achieved is actually paid out in cash. The other half is converted into deferred shares or options which have to be held for a further two year s before they are vested.

A matching amount - in other words equivalent to half the bonus - is awarded in the form of performance shares. These are subject to additional targets and can only be vested if these goals are met over a three-year span. Has BHP Billiton been rewarded by market commentators in trying to achieve fair and transparent packages?

"The answer is a resounding no," says Mr Fraser. He blames this on media sensationalism of pay issues, lack of a holistic way of judging performance practices, the fact that local communities are parochial, and because governance has not yet become a leadership function. "We must focus on value creation as well as protection," he says.

"We must have governance for performance, not bureaucracy for failure".

Some companies will find the BHP Billiton model too complicated, but it is well thought out and shows that the corporation has made significant progress in overcoming corporate governance problems.

Note: The value drivers were published last year and reflect last year's scorecard measures. The company will revise these each year in line with its strategy, along with the scorecards. The measures are set annually and can and do change. Click here to learn more.