Guerdon Associates and CGI Glass Lewis held their 13th annual Governance and Remuneration Forum in Melbourne on 7 March and in Perth on 11 March.

The 2019 Forum focussed on exploring how to find and set a moral compass post the Hayne Royal Commission with an AGM season that saw 20 remuneration report strikes in the ASX 300 a significant increase over the 11 in 2017 and 18 in 2016. The discussions were lively, with many and varied perspectives from issuers and investors aired and discussed.

Proxy adviser review

CGI Glass Lewis provided its debrief of the 2018 proxy season. While the Forum is conducted under the Chatham House rule, with their permission we have summarised their discussion topics which included:

• An autopsy of the big 4 bank remuneration proposals
• An update on activist shareholder proposals
• Global trends in remuneration structures
• A discussion on protest voting at the election of directors

Autopsy of bank remuneration

Three of the 2018 strikes were against the remuneration reports of the big 4 banks, some of the largest companies on the ASX. Two of the banks received majority protest votes. The autopsy of bank remuneration focused on:

Three of the 2018 strikes were against the remuneration reports of the big 4 banks, some of the largest companies on the ASX. Two of the banks received majority protest votes. The autopsy of bank remuneration focused on:

• 2018 performance
  • While all showed a negative TSR for the year, CBA had the best performance that happens to align with its position of the only bank not getting a strike
  • The cash earnings of the 4 banks was down other than Westpac which was flat
  • Remuneration report votes were aligned with short term TSR, rather than financial performance
• Publicity factor
  • The adverse publicity of the executive and director performance at the Royal Commission seemed to align with the voting outcomes
• Severity of misconduct
  • Without drawing too many conclusions on the severity of misconduct, it was noted that while CBA may have been the only bank to avoid a strike, it is not widely held that their misconduct was the least severe.
• Extent and severity of remuneration adjustments
  • More CBA executives terminated and/or suffered no, or reduced incentive payments relative to other banks
  • Remuneration report outcomes appeared aligned to the extent and severity of executive pay outcomes, and only CBA did not receive a strike of the big 4

In summary, the message of the autopsy was that investors want to see accountability for the misconduct revealed in the Royal Commission which, prima facie, did not warrant the awarding of the incentives that were given. This is particularly so given the impact on TSR.  The Royal Commission among other things also illustrated that, at least initially, some executives and directors generally demonstrated a lack of accountability to shareholders and compassion for customers impacted by poor misconduct.

Activist Shareholder proposals

In 2018, 8 companies faced 18 shareholder proposals compared with 2017 where 7 companies faced 14 shareholder proposals.

The proposals predominately focused on climate change reporting. However, there were a growing number of human rights issues including matters concerning asylum-seeker rights, indigenous land rights and modern slavery.

To date, none of the proposals have received majority support from shareholders.  However, both the total number of proposals and the number of proposals receiving significant shareholder support is up.  Notably, 44% of shareholders supported the climate change and energy advocacy report at Origin last year and 40% supported the climate change reporting proposal at Whitehaven Coal.

It is reasonable to expect that activist shareholders will continue with an increasing number of proposals on climate change in particular.

Election of Directors

In 2018, 25 Directors had more than 25% negative votes by proxy, up from 16 in 2017 and 14 in 2016.

It appears shareholders are becoming more willing to vote against the re-election of directors which is a far cry from not too many years ago.

CGI Glass Lewis expect these protest votes against directors to be an increasing matter in 2019.

Global trends in remuneration structures

The changing global trends in remuneration structures were highlighted.

Notably, the restricted share plans in the UK were pointed to as an emerging structure. These involve grants of fixed equity that vest over a longer period and may or may not be contingent on a performance measure.

France now has a binding vote on remuneration policy, whilst both the UK and South Africa have adopted double votes on remuneration – one vote on the policy and one vote on the implementation of the policy. Since 2014, publicly-listed companies in the UK have been required to put their remuneration policies up for a binding vote every three years along with an annual advisory vote on the remuneration report itself. South Africa, whose governance practices are heavily influenced by the UK, have also adopted annual voting on both the remuneration policies and implementation reports from 2018.

The UK Investment association has been calling for a broadening of the triggers for the application of malus and clawback provisions

Attendees were reminded of the “Macedonian Effect” where exceptional but widely publicised events can lead to overregulation and creating excessive constraints for the majority as a consequence of actions of a minority.

Remuneration frameworks – social license to operate

The panel on remuneration frameworks was asked to consider short term pay in the context of long-term objectives and a social licence to operate – not an easy discussion.

The panel firstly considered what does short term pay meant to investors, executives and boards and it was posited that the starting point in the minds of many an executive and board may be the prior year’s STI payment or target performance.

An alternative perspective based on the premise that the wider community does not accept the levels of executive pay and payments of incentives, suggested that STI structures can work if they are genuinely reflect the volatility in financial outcomes, i.e. STIs become more volatile.

This discussion raised the question of budget-setting. The responses varied between analysts’ expectations, what the company expects to achieve and always reflecting stretch. The different views reflect the wider market and highlight the confusion in understanding remuneration frameworks and how hurdles are set. It really then does become an issue of ensuring investors understand both how the remuneration is structured and the basis of the budget-setting – not that simple in the context of continuous disclosure.

A participant noted the problem of companies and boards moving to the centre with a vanilla remuneration structure focussed on relative TSR and how it is both a lottery but can result in payouts every 2 or 3 years.  There was general agreement that relative TSR is a less than satisfactory performance metric and is not linked to behaviour outcomes.

Responding to the Hayne Royal Commission panel

The Hayne Royal Commission identified a wide range of general and specific misconduct and indicated that doing the wrong thing is often perpetuated because to do the right thing may result in a competitive disadvantage. The panel was asked how boards can address the issue of establishing and maintaining a ‘moral compass’.  That is, how can boards ensure the company is, as Hayne said, “doing the right thing”? While the response varied the theme was evident – boards need greater information and processes that ensure they are better informed. The discussion included the following:

• Performance evaluation reviews undertaken by third parties to provide valuable independent insight into the operations of the board;
• The need for directors to have access to relevant information from across the business
• Observing the behaviour of the CEO in particular if he/she is restricting and controlling director access to senior management and information
• Directors can learn much more from outside the boardroom

The six behavioural points raised by His Honour Commissioner Hayne were said to provide a standard that directors could use. Directors should know what is expected of them and, in particular, their role to challenge and the form of that challenge.

It was noted that one of the key roles of the board is to appoint the CEO. Therefore, that process should ensure robust procedures to ensure the “moral compass” of the CEO is aligned with that of the board. Examples were given of the increased focus on culture and conduct risk. Many companies, for example, do not have safety in the balanced scorecard as that should be a daily focus of management and all employees. The experience of Macquarie Group identifying concerns with the conduct in a business line, investigating and correcting it was presented as an example of how to deal with conduct risk efficiently and promptly that provides a message to the market and the wider group.

Additional discussion included:

• How robust are our formal systems?
• Do we have good whistle-blower processes? Has there been a whistle-blower? Why not?
• As a director, how confident am I that bad news will reach me?
• Is the internal audit function being effectively utilised?
• Does my board demonstrate diversity of thought?

The experience of panellists was that boards select directors with regard for their moral compass and how they will apply it in the boardroom. This is done largely through reference checking, interviews and scenario planning.

Research has indicated that oligopolies can give a low priority to customer service while increasing profits and their market value. It was put to the panel, if correct, what is the likelihood that AMP, the banks and companies like them may eventually go back to placing a low priority on the customer?

It was pointed out this may have happened in the past but given the rise of social media and the immediate feedback by customers on numerous websites, boards of oligopoly companies can no longer be complacent.

The recent 4th edition of the ASX CG Principles’ commentary to recommendation 3.1 (A Company must disclose its values), emphasises the importance of reputation, and references Commissioner Hayne. However, Commissioner Hayne indicated that reputation was an outcome of doing the right thing, rather than an end in itself. Panellists were asked if there is a risk that companies will get the emphasis wrong?

• Hayne has made “doing the right thing” a focus. It should be front and centre of all directors’ thinking at all times.
• The question of “Should we do this?” must have primacy
• Directors should be looking for the unintended consequences of any action

The recent focus on financial versus non-financial risks as a performance measure was explored.

Directors, we were told, are equally interested in financial and non-financial risks -remuneration is merely an adjunct to that interest.

Investors want to understand the performance measures chosen by the board and, most importantly, why they have been chosen.

A view was put that both of the financial and non-financial risks are intrinsically connected.

One director cautioned of the dangers of using remuneration for significant consequence management.

Panellists were asked if directors should set culture objectives and, if so, how:

• Setting culture objectives should just be one part of the process and would be reflected in standardised reports going up to the board
• It is equally a normal part of the performance review process to discuss values and attributes although it is difficult to imagine a hard /specific measure for culture
• Values drive culture
• Boards need to act when there is a problem

It was suggested that engagement surveys are often lacking as some do not ask participants if they have seen the supervisor acting when breaches have been identified.

Panellists were asked what the most important take-away from the Royal Commission is for directors and executives at companies other than financial services?

• Culture, governance and remuneration are the triangle of issues for all businesses
• Directors should intentionally go looking for things and not wait for the adverse to surface
• There should be a process of continual improvement – employee safety is a good example of the process of continual improvement
• The Royal Commission should make all directors stop and look at their business and understand the link between actions and consequences
• Investors are expecting to see variability in pay outcomes, and if there is not such variability, they want to know why not

Some other comments and discussion included:

• It was not expected that we would see boards establishing culture and conduct committees as these are the responsibility of all directors
• The discussion of non-financial measures suggested that much could be learned by looking at other sectors. Medicine and aviation, for example, have significant non-financial risks to be considered
• The issue of mandatory clawback was recognised as a very challenging one and that if boards were depending on clawback provisions, it may well be too late.

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