No one size fits all in executive remuneration
03/12/2007
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For once the media hype has been correct.  2007 has seen a hostile AGM season for executive remuneration.  And this is not because the proxy advisers and investors have all of a sudden decided to become more assertive.  If anything, our experience is that they have become more accommodating.  They have had to be, as more boards realise that “average” executive pay is no longer appropriate.  And by this we do not just mean remuneration levels.  We also mean how boards pay executives; that is, how much for warming the seat, how much for achieving results, the colour of the money (i.e. cash, options, rights, or shares), and the timing of pay delivery (i.e. now or some time in the future).  The result is that more boards are willing to go out on a limb, and pay “differently”.

This article is a reprint of a Guerdon Associates’ opinion piece that appeared in the Australian Financial Review on 23 November 2007.

Directors’ duty to shareholders is to oversee remuneration frameworks that are effective at attracting, retaining and motivating the best talent possible.  This talent no longer wants to be rewarded for achieving outcomes over which they have no control.  And they are right.  Better to reward executives for outcomes over which they do exert influence.  Directors realise this and, to their credit, for the most part so do the proxy advisers and investors.  The one size fits all remuneration where all executives are paid in a similar way is going the way of the dodo. 

In this, at least, the experience of private equity has been instructive.  Private equity firms buy companies with specific problems and opportunities.  And these are unique.  This uniqueness makes them potentially valuable.  Boards and their executives realise that their companies have unique attributes as well.  Leveraging off these will deliver value.  This means that performance requirements for every ASX listed company could be different.  No longer will a boiler plate three year period of total shareholder return performance, relative to a disparate group of companies, be appropriate or enough.  Especially when an individual has perhaps up to a million dollars riding on the outcome, and shareholders have to wear these million dollars as an expense. 

What a waste most executive long term incentive remuneration has been.  Shareholders should be up in arms. 

In fact, they have been.  But, it seems, only to disagree with directors’ attempts to change executive pay to better justify the expense.  Why is this?  Most executive remuneration experts agree that investors and proxy advisers have been more accommodating than ever.  But the extent of accommodation to different executive pay has, at best, been inconsistent.  The reasons have to do with the proportion of companies seeking change and how they disclose it. 

The sheer volume of diverse executive remuneration arrangements has increased significantly from last year.  Proxy advisers and institutional investors are now faced with more remuneration reports that they can no longer easily tick off against a standard set of requirements.  Each non-standard arrangement requires closer scrutiny and thought.  This is hard work, given that our research shows remuneration reports often require a PhD to understand them

Inconsistencies in assessing their merits are bound to occur, resulting in sometimes a greater proportion of no votes than is justified.  And to be fair, the proxy advisers’ and investors’ task is not helped by sometimes extraordinarily poor disclosure. Many companies are trying to shoehorn their increasingly non-standard executive pay into a description that looks like a more traditional remuneration framework.  No wonder they do not make sense.  Suspicions are aroused.  Directors would do better to tell it how it is.

Executive pay is often the outcome of a negotiation.  To get the best talent directors are required to exercise judgement on the levels and structure of pay to get, keep and focus an executive on results that increase shareholder wealth.  Too often the disclosures fail to reflect these plain facts and reveal the thinking that is behind their executive pay.  Even better, directors could take the time to test the pay reasoning face to face with their main investors and proxy advisers.  This is why some companies departing from the norm still sail through their non-binding vote, sometimes with applause.  Others try to rivet boilerplate executive pay disclosures over a funnily shaped pay structure, fail to test it with investors, and receive a hail of dissenting votes.

Expect more of the same in 2008 as more companies depart from the one size fits all “pay them this way” framework.  More boards should and will try for more effective executive pay.  But each company that does is in for a new learning experience, as are their investors, in trying to assess the extent that it is in their interests to vote for the plan.  But on the whole, Australian investors will be the better for the greater variety in executive pay that is yet to come.

© Guerdon Associates 2021
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