In early 2007 companies and their boards were coming to terms with their first experience of shareholders voting on their remuneration reports. It was a whole new world as shareholders now had a non-binding advisory vote that required them to judge executive remuneration, while company directors had to apply more time to consider and explain it.

Much has happened since then. Inquiries, new disclosures, different taxes, corporate and prudential regulations, changing guidelines and fashions, economic booms and busts, complexity and sophistication. The two strikes rule eventuated in 2011 and, every day, we continue to hear and read about the competing tensions in executive remuneration and governance, both in Australia and globally.

A decade ago Guerdon Associates and CGI Glass Lewis (then known as Corporate Governance International) recognised the need to facilitate dialogue and understanding between institutional investors, company directors and the regulators. The first annual Forum on Executive Remuneration and Governance was born!

On 8 and 10 March this year, Guerdon Associates and CGI Glass Lewis were proud to facilitate the tenth Forum, at which more than 200 NEDs, institutional investors, c-suite executives, and regulatory officers participated in lively debate and ideas-sharing discussion.

While the Forum continues to be held under the Chatham House Rule, the key points of discussion emerging from the Forum can be shared (without attribution other than those of CGI Glass Lewis on its proxy advice). Note that this is a summary of the discussion points, reflecting a diverse range of views from participants. They may or may not have validity.

CGI Glass Lewis looking to 2016

CGI Glass Lewis is happy to share its approach in 2016 with subscribers to our Guerdon Associates Newsletter.

Curating the Board: CGI’s focus in 2016 will include:

• How well are boards addressing the ASX CGC recommendation to have and disclose a board skills matrix.

• How boards are addressing the need for increased diversity of age, culture, gender and experience among other things, both in management and on the board.

• What are they doing and saying in respect of executive and director succession.

• To what extent are the NEDs overcommitted.

Remuneration hot topics grabbing CGI Glass Lewis’ attention include:

• Has there been a positive TSR outcome when the relative TSR ranking has resulted in vesting of the LTI? In other words, CGI Glass Lewis is looking for a positive absolute TSR as a gateway to the LTI if relative TSR is used to measure performance, or a discussion of how a company ensures that executives do not get awarded for loss in shareholder value.

• What is the rationale for any retention awards?

• What is the LTI allocation methodology – fair value or face value?

• The attractiveness of share options – CGI Glass Lewis consider options to be an effective equity instrument (but note the later comments below).

Corporate actions: CGI Glass Lewis will continue to take a pragmatic approach in its review of corporate actions and advice to its client base.

Focus on environment and sustainability issues: CGI Glass Lewis has entered into a partnership arrangement with Sustainalytics Inc, a global responsible investment research firm specializing in environmental, social and governance (ESG) research and analysis. The firm offers global perspectives and solutions that are underpinned by local expertise, serving both values-based and mainstream investors that integrate ESG information and assessments into their investment decisions.

CGI Glass Lewis will be increasing its focus on how companies and boards are managing their environmental and sustainability issues.

Incentives and innovation:

This was a lively discussion, replete with concrete examples, disagreements, and differing points of view that each, in their own way, were probably valid.

The discussion on how should pay and equity structures develop to support the demands of an innovating Australian economy identified some common ‘wants’.

No matter whether it is an entrepreneurial start-up or small cap, or larger business growing through its lifecycle, there was a continuing call to create safe and inclusive environments that encouraged employees to innovate and ‘have a go’.

Participants agreed that the corporate environment and pay structures should be promoting healthy risk-taking. There was a view that if executives, and other employees, have equity, or sufficient ‘skin in the game’, they will be prepared to take appropriate risks because they want to see that equity grow. At the same time, the ‘skin’ helps to ensure that it is not wild and reckless risk-taking. However, if an executive accrues too much equity as a proportion of their personal wealth, and is unable to liquidate this equity for insider trading or governance reasons, it could make the executive too risk averse.

While CGI Glass Lewis is supportive of the use of share options by companies in the right circumstances (see above comments), boards were reminded that investors do not want to be the ones taking all the risks. This was countered by an alternative view that investors, relative to employees, take on less risk because they diversify their investments. It is therefore in their interests for each company in their portfolio to take on more risk, while such a predisposition may be career limiting for the executives in these companies. Option structures can provide significant leveraged upside for employees with, it was claimed, no downside. The asymmetry of such pay structures needs to be considered prior to timely engagement with investors.

An innovative culture is one where employees will feel like owners. This can mean that failure does not necessarily bring with it loss of pay opportunity.

A theme – acknowledged by investors, directors, proxy advisers and entrepreneurs – was that the remuneration structure should be ‘fit for purpose’. There was a call, therefore, for investors and investor service providers to re-visit their guidelines to ensure they recognised this need.

A clear example in the Australian context would be high-growth early-stage companies needing highly qualified directors from the North American market. They need to compete with option packages that will attract the right talent.

A common theme to emerge was a recognition of the shallow pool of entrepreneurs in Australia vis-à-vis the deeper pool and more collaborative culture of Silicon Valley. The innovation nation should be looking at what we measure, how we reward/remunerate it and how we partner with our employees, contractors and suppliers.

An appropriate summary for the ears of investors, proxy advisers, NEDs, executives and regulators may be to forget ticking boxes and meeting guidelines, think longer term and work on what is ‘fit for your purpose’!

Will we really try and regulate culture?

The Forum provided an opportunity for participants to consider the governance and regulatory difficulties around the current debate on culture.

It was recognised in all quarters that organisational culture is not something that can or should be regulated. That type of approach leads to an environment heavily reliant on compliance with the consequent loss of individual and, in turn, corporate innovation and subsequently performance. An internalisation of ethics permits innovation and performance. A rigorous and unbending set of rules prescribing behaviour does not mean ethical standards are internalised. They also do not allow leadership to consider and implement strategies within a defined risk framework as freely as they need.

Building remuneration structures that reward achievements around culture may not be what is required. Culture should be at the core or fundamental to the way in which business is carried on. You may, therefore, consider malus or clawback arrangements to address culture transgressions but only in the sense of providing a check-and-balance structure.

Regulators, investors and other stakeholders will be quick to identify any gap between what you say and what you do. Remuneration, evaluation and promotion systems are part of the system, policies and structure framework that underpin a culture. These need to be consistent with the values espoused. An example of inconsistency was a financial planning services organisation that espoused providing good investment advice, but paid its planners purely on volume of sales. The espoused value was not reflected in the system of paying people.

A common theme was that companies and regulators should avoid an overreliance on compliance. There are other ways and, in this regard, there is no substitute for critical enquiry at board level.

It is the systems, policies and structure that support an organisation’s culture and which provide the tools for managing risk. If the board asks of itself what is the culture, how can we measure it and what are we doing to close the gaps, it is on the right track. However, another view was that culture was one element of risk management, and it was risk management that should be the primary focus, per se.

Guerdon Associates and CGI Glass Lewis look forward to facilitating and presenting the 2017 Forum on Executive Remuneration and Governance in Melbourne and Perth. The dates are expected to be in March 2017 and we will remind you later this year and with plenty of time to lock it in the diary.

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