Executive remuneration is scrutinised to ensure executives’ interests are aligned with shareholders.

Beyond the simplicity of better performance leading to higher realisable pay, investors who expect higher returns from riskier investments should also expect executive remuneration opportunities to incentivise and reward appropriate levels of risk taking by executives. For companies with high growth outlooks and expectations, we would expect to see:

• Higher incentive leveraged remuneration opportunity to incentivise executives to successfully implement strategies that can significantly move the share price. That is, incentives would make up a higher proportion of total remuneration.
• For higher risk companies, larger incentive value ranges from threshold incentive to maximum incentive, to incentivise executives to go beyond expectations.
• Likewise, for companies with low to moderate growth outlooks, we would expect executives to have a higher fixed remuneration as a proportion of total remuneration.
• Similarly, for lower risk companies, lower incentive value ranges from threshold incentive to maximum incentive, to ensure executives remain within conservative risk parameters for sustained earnings and reliable dividends.

Guerdon Associates has tested this empirically by analysing ASX 100 CEO remuneration structures against company betas. Beta is a proxy for market risk – it measures the volatility of a company’s share price in relation to market movements. From elementary finance, riskier investments have the potential to deliver higher returns. Thus, for companies with higher betas, we would expect to see more incentive leveraged remuneration and lower fixed remuneration as a proportion of total remuneration.

The table below categorises ASX 100 companies into GICS sectors. It displays the median company beta for each sector.

For this analysis, “Incentive Leverage” is defined as the sum of maximum short-term incentive, maximum long term incentive and long term equity opportunity divided by total fixed remuneration. “Incentive Stretch” is defined as total maximum incentive divided by total target incentive.

Table 1: ASX 100 median beta, incentive leverage and incentive stretch by GICS sector

• The consumer staples and utilities sectors have relatively low beta, consistent with defensive sectors resistant to economic volatility.
• The information technology, real estate and energy sectors have relatively high beta, consistent with economic cycle sensitive sectors.

The hypothesis that incentive leverage is higher for higher risk sectors is not supported by the evidence. That is, there does not seem to be a clear relationship between beta to incentive leverage and incentive stretch.

Figure 1: Scatterplot of ASX 100 company betas against CEOs’ Incentive Stretch

Figure 2: Scatterplot of ASX 100 company betas against CEOs’ Incentive Leverage

The observations in Table 1, in conjunction with the above two scatter plots suggest there is no relationship between beta and these elements of CEO remuneration. A further regression test confirmed there is no significant relationship between company beta against incentive leverage and incentive stretch (as a second test, outliers in Figure 2 were removed but there was still no significant relationship).

There are a few potential reasons for the above observations. ASX 100 companies are large and may not have varied enough risk profiles for the data to show a noticeable statistical relationship between company beta and the variable portion of a CEOs remuneration. Companies in the ASX 100 may also be more sensitive to pressure from proxy advisers and shareholders to meet ‘market practice’ remuneration structures in line with other ASX 100 companies.

Does this mean that these CEOs are not being incentivised to match the risk profile of the company they are running?

Not necessarily, the above ratios may not tell the whole story. This study has not considered the equity vehicles used in these frameworks. For example, the maximum value of options with no performance hurdles may result in a relatively low Incentive Leverage, but high realisable value. The realisable value of options can be far higher than their expensed value under Australian and international accounting standards, and can encourage executives to increase risk taking due to the leveraged position an option provides.

Given proposed changes to the Corporations Act (see HERE) options may become a less common equity instrument in executive remuneration frameworks. Some companies may move towards share appreciation rights or SARs, however they currently do not see much use amongst ASX 100 companies currently.

However, based on the evidence, it does appear that “one size fits all” executive remuneration dominates the ASX 100, and there is not much tailoring or variation to each business’s inherent riskiness.

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