The world’s largest fund manager, BlackRock Inc, (with more than US$5 trillion of AUM) has been in the news in recent weeks calling on company board directors to be more effective on executive remuneration.

 

In his January letter to the CEOs of companies in which BlackRock’s clients are shareholders, BlackRock’s Managing Director, Larry Fink, said “….When BlackRock does not see progress despite ongoing engagement, or companies are insufficiently responsive to our efforts to protect our clients’ long-term economic interests, we do not hesitate to exercise our right to vote against incumbent directors or misaligned executive compensation….”

 

More recently, BlackRock’s Asia Pacific Director of Governance, Pru Bennett, was in the Australian press calling for boards to have a much closer look at their long-term incentive structures. She was quoted in the Australian Financial Review of 27 March 2017 as saying that some RemCo chairs “try to please all without coming up with what’s right for the company and then communicating it to shareholders. While these structures do not result in egregious outcomes of pay, they do not necessarily result in rewards when reward is deserved and they may result in reward when reward is not deserved.”

 

Pru Bennett used the coverage to remind directors of BlackRock’s research paper of 2015,” Time to Rethink Executive Incentive Programs” .

 

The headline finding of the research, and of particular concern to BlackRock, was that Australian companies “appear to be herding around a standard model” in response to proxy advisers and advice from remuneration consultants. The paper suggested boards are being pushed to conform to a cookie-cutter approach, whereby LTI plans are simply designed to “tick-the-box” and match “ideal” criteria.

 

The cookie-cutter is hindering companies’ ability to shape their own company specific LTI plans, while giving rise to increasingly complex structures that include measures such as relative total shareholder return (RTSR). This raises the question – are proxy advisers devoting the time to effectively analyse each company individually, or are they biting off more than they can chew?

 

Pru Bennett’s comments in March indicate that BlackRock has not seen much of a change since the research was done.

 

The paper reviewed the impact of the 2005 introduction of the non-binding vote on remuneration reports. The research found the following changes in LTI remuneration between 2005 and 2011:

 

• The changes significantly improved disclosures – particularly in relation to performance measures and vesting conditions;

 

• A surge in zero exercise price options (ZEPO) use – meaning employees receive a benefit irrespective of when there is an improving share price or when the share price falls, conditional on performance conditions being met;

 

• An expansion in LTI performance measures – running a large business is complex, and thus BlackRock suggests performance metrics should not be constricted to a single measure (although there may be cases where it is appropriate); and

 

• Increase in the popularity of RTSR – by 2011 76% of companies used RTSR, up from 59% in 2005.

 

Readers will not be surprised to hear there have been very few movements away from this in the 6 years that have passed since this analysis.

 

The paper critiqued the effectiveness of RTSR and EPS as LTI measures.

 

In deep markets like the US and UK, RTSR can be an effective measure as there are many more similar peers by risk profile, industry, size, etc. Unfortunately, for Australia’s smaller market, peer groups often include companies that fail to share these similarities. This can have significant consequences on the outcomes of an LTI plan, as outlined by the paper’s example:

 

“Consider this example of two large, globally diversified Australian mining companies using two measures of RTSR: an international mining peer group and the MSCI. When commodity markets rise, executives miss out on the RTSR calculated from their mining peer group, because riskier companies – often leveraged to just one or two minerals – do relatively better.

 

But when markets fall, the executives do well against the mining peer group, but not the MSCI. So, on average, the executives may get half of their potential RTSR, whatever the markets are doing – and more importantly, irrespective of issues under their control.”

 

EPS measures are equally troublesome. The paper states that targets set before the GFC proved to be unrealistic (too high), resulting in under-reward for relatively good outcomes. There is often a concern that EPS targets set for the next three years may be too low – resulting in over-reward. It is simple to say that these rewards will balance out over time, but does that imply it has the same effect on an individual’s performance?

 

At the time of the paper’s release, BlackRock had received feedback from its clients and directors that the purpose and value of LTIs as they were structured was questionable.

 

Conversely, the feedback BlackRock received on STIs was somewhat different – not surprisingly, directors indicated they more easily understood, and thus valued, STIs.

 

The paper, in line with current emphases from others, supports simplicity for equity incentive plans. It suggests that this could be achieved by using internal measures that are more controllable, as opposed to TSR (whereby market movements make up approximately 70%).

 

BlackRock’s research and views can be found in its paper “Time to rethink executive incentive programs” HERE. The paper covers a broad range of topics specific to long-term incentive (LTI) plans.

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