Regnan suggests an answer to executive remuneration
06/04/2009
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Regnan is owned by institutional investors and provides governance research services to investors responsible for 16% of the institutional funds invested in Australia.

On Tuesday 17 March 2009 they released their guidelines for executive remuneration.

In essence they advocate that above a board-defined threshold, all pay be deferred in company stock, to vest in equal instalments in the 5 to 10 years after the payment was granted.

This structure, says Regnan, will encourage executives to focus on sustainable long term returns. In addition, they advocate limitation of termination payments to 12 months’ pay, unless shareholders approve otherwise.

One of the several assumptions that Regnan appears to make is that all institutional shareholders want sustainable long term returns. Given the huge and growing proportion of funds managed by opportunistic hedge funds, private equity and active traders on behalf of many pension funds, this is clearly not the case.

Outside of the index funds, most fund managers live or die on the basis of quarterly or half yearly returns. It is primarily the very large funds with “permanent” core holdings that may want companies to focus on the long term.

In addition, there is an implicit assumption that all companies can have long term strategies. Again, this is not the case. The fashion retailer lives by the success of their buyers’ 3 month seasonal decisions, the car dealers and real estate businesses require stock churn, the engineering services businesses only have to worry about carrying a few weeks of parts inventories, as indeed does the fund manager whose performance fee is assessed on a carry forward basis each quarter.

The examples are at least as numerous in a services based economy like Australia’s as those businesses with major capital investments requiring long term consideration.

In addition, we have pointed out before that diversified investors may want executives in companies across their portfolio to take risk to maximise portfolio returns for a given overall portfolio risk profile (see HERE).

Another consideration not addressed is the perplexing issue of executives who do not retire gracefully, but jump ship to join a competitor. What happens to their deferred equity? The only sensible course is to ensure the deferred equity lapses (otherwise the employee and new employer have major conflicts of interest). If it lapses, their new employer will merely make them whole with its own deferred equity, as they do now. So, in effect, inside knowledge will encourage executives to jump ship at any time it may spring a leak. This way out will not discourage “excessive” risk taking for most executives as proposed by Regnan.

Nevertheless, for high capex, truly long term companies, some elements of the Regnan proposals have merit, and are closely aligned with our own ideas for “hold through retirement” equity remuneration approaches suggested before (see HERE).

But the difficulty pointed out by Regnan, and us, is the taxation on unvested equity at termination. We have asked the government to address this in our submission to the Treasury review into Australia’s Future Tax System (see HERE).

The Regnan proposal can be found HERE.

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