A faultless executive remuneration framework! We have a checklist
07/07/2017
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There, that got your attention.

 

Alas, there isn’t one. That is, there is not a faultless remuneration framework. We still have a checklist.

 

Nevertheless, the absence of a perfect remuneration framework will not stop people (e.g. executives, remuneration advisers, or investors) trying to sell you one, or having one foisted upon you. Beware.

 

Activity has stepped up somewhat, as various remuneration committees and their advisers are bolstered by alternative frameworks that they believe are more acceptable in the UK after the UK Investment Association suggested several alternatives to the traditional fixed/STI/LTI model (see HERE).

 

Yet, despite official sponsorship by the body that invented the guidelines that proxy advisers and other stakeholders have copied, not everyone is on board in considering all the alternatives they have presented as acceptable. This is as we expected. It simply takes too much effort and expense for investors to consider each alternative on its merits for a particular company’s situation during an intense proxy season. “Fit for purpose” is a phrase missing from their lexicon. Much better to revert to the simplistic and always unworkable “best practice”. That is, it is far easier to pick one, as Hermes has done, and be done with it (see HERE). Back to one size fits all. Unfortunately, there is no agreement to which size it is. Hence, in the UK, as in Australia, we are observing institutional investors and their advisers being somewhat hesitant to change.

 

The latest remuneration iteration doing the rounds is what is often referred to as a “hybrid” plan. This typically means combining the STI and LTI buckets, and rewarding executives this largesse initially on annual results, with significant deferral into equity over multi-year periods, with a final and less arduous test or gateway to ensure reasonable performance has been sustained.

 

Hybrid schmibrid – an STI by another name (such as hybrid) would smell as sweet. A “hybrid” plan emphasises short-term performance. An executive not achieving short-term results receives zilch. The fact that there is another hurdle down the track will not be the primary focus of an executive’s attention.

 

However, to be fair, it may be a good fit for purpose for particular types of companies, such as defensive high working capital stocks that require sustainable yield e.g. consumer staples.

 

Unfortunately, being fit for purpose does not appear to be a concern for some investors and proxy advisers. They smell a rat. This could merely be a reflection of the fact that their olfactory senses have suffered under the strain of detecting “sneaky” executive pay practices last proxy season. Or they could be onto something. They reason, rightly enough, that if uncertain remuneration was replaced with sure-bet remuneration, the maximum value of the latter should be less than the former. And this is where the problem is. They reckon that an uncertain LTI rolled into a more certain STI should not be on a one for one basis.

 

So, for remuneration committees considering a “hybrid” incentive here is our checklist:

 

  • If considering a hybrid plan because executives do not value LTIs, check first if the LTI can be made more meaningful and appealing
  • Review remuneration framework alternatives in terms of their fitness for purpose. Do not take to heart the initial responses of your remuneration adviser, investors or proxy advisers who are aghast that you may deviate from a traditional fixed, STI and LTI model. Look first at what suits the business.
  • Look second at the response of the investor community. You need not worry about the executives by this stage, as they should already be on board. You need to make a judgement as to whether it is worth the incredible effort to do something different. Directors need to be pragmatic. Sometimes it is better to save ammunition to fight the good fight.
  • If you proceed to do something different, like a “hybrid” plan, make sure that the economic value of remuneration is about the same before and after the change. Have the rocket scientists (like us) check it out, and wrap the report in flowers to present to proxy advisers and investors. They are predisposed to be suspicious, so supplying the facts and figures is the only way to counter their inclinations.
© Guerdon Associates 2024
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