This time each year we dust off our crystal ball to provide our outlook for director and executive remuneration for calendar year 2020.

The economy and pay

The Australian economy, as with all other China-exposed economies to an extent, will be knocked off course in the first half by the coronavirus. It should quickly recover in the second half from local and global stimulus, and resume moving to be more balanced across sectors. The short term shocks may correct some of the frothy equity valuations that would otherwise tempt excessive risk taking, although this is not likely given the extent of easy money, and the absence of alternatives, despite a pause in quantitative easing.  Global risks and uncertainty remain, but to an extent are likely to stabilise as the US election cycle runs its course. Growth should quickly resume after the bushfire and coronavirus shocks subside.

All sectors, but particularly energy, resources, industrials and financial services, will also need to amend executive structures to address longer term investor sustainability concerns. This will present many remuneration strategy issues, given the time scale associated with re-positioning asset mixes across whole industries to, say, lower carbon intensity, is considerably longer than a typical 3-year long term performance period.

Investment in higher growth companies will continue. Since executive pay will continue to be a function of supply and demand, the recent higher executive demand in those industries will continue to cause higher rates of pay. Technology disruption, and counter-technology investment in fintech, professional services and the public sector will see some job families benefit and others wilt.

While proxy advisers and institutional investors will continue to have a moderating influence, some of their attention will focus on pay structures, and how some industries tackle ESG risks to lessen prospects for stranded assets and value loss.

Remuneration structures that moderate risk necessarily have to differ from those that focus on entrepreneurial growth. Both sorts of structures will be evident in coming years given the dispersion of investor money spilling into both buckets.

Consequence management and discretion

Following compliance failures in financial services and the Hayne Royal Commission’s finding that boards failed to exercise their discretion to forfeit executive incentive payments, all banks and most other larger financial services companies have adopted consequence management frameworks. In effect, these are structured guidelines that identify to whom malus and/or clawback should apply, and to what proportion of the incentive. Boards then only have to apply positive discretion not to dock an executive’s pay. Much of the focus in these frameworks have been on employee misconduct and non-compliance.

Larger non-financial services ASX-listed companies have also started to develop and apply similar frameworks. Other large companies that have not yet done so may follow suit once ASIC releases its finding on remuneration governance in 21 of the ASX’s largest listed companies (see HERE).

We expect that consequence management frameworks will be considered by more companies outside of financial services and the ASX 50 in 2020 and beyond. One obvious area for application outside of financial services would be in regard to resources company employee safety. This would be an appropriate and responsible, if incomplete, response to breaches of employee safety standards, identified by ACSI recently as a key area of focus (see HERE) .

ESG next big thing

The 2019 AGM season saw less “strikes” and lower negative votes against remuneration reports compared to the 2018 season (see the article in our forthcoming March newsletter).

While banks, and others, will demonstrate how well they have responded in their 2020 remuneration reports and Notices of Meeting (for CEO equity grants), it is likely that proxy advisers and institutional investors will have moved on to their next area of focus – ESG. While each issuer will have different levels of ESG risk exposure, most large ASX-listed companies will be fair game for activist investors. And consistent with a rapidly developing trend from the last two years, the activists are finding greater levels of support. European investors, Australian industry superannuation funds, and lately, the world’s largest index funds (BlackRock and State Street) will use their voting power to bring about change. While some will confine this power to director election resolutions, more are expecting executive pay structures to recognise and respond to ESG risks.

Shareholder engagement will continue to be difficult. Boards need to understand that proxy advisers and investors are swept into the same zeitgeist as boards. They know they have to respond to new concerns, but have not the knowledge or answers on what an adequate response is. Therefore much of the engagement in ESG matters, and how it relates to executive pay, will involve a learning process. That is, saving the planet is not something that can be encompassed in a traditional 3 year long-term incentive cycle. There are remuneration frameworks that, however, can accommodate ESG, and assist boards respond to looming stranded asset risks, but these are not of the traditional variety.

There will also be some investors that vote using blunt 3^rd party scoring systems based on public disclosures, including some investors that may not have a human behind vote lodgements (see HERE) . In this regard, companies need to be cognisant of not only having something that works, but ensuring the right data is in disclosures to get a decent 3^rd party score.

Contrary to some directors’ experience and observations, we have observed that proxy advisers are getting better at what they do. That is, they are improving on accuracy, most are improving on consistency of judgement, and, for most, are open to engagement, albeit at a time that suits them. Boards can be blindsided, but usually this is because of a failure to understand what is important to the proxy advisers, and addressing these in disclosures and engagement meetings.

Alternative remuneration frameworks

The alternative remuneration framework caught a virus and died in 2018. FY2019 saw a reversion to the tried and true traditional STI and LTI model. 2020 disclosures will repeat this, However, stemming from new financial services accountability law known as FAR (see HERE) and APRA regulation CPS 511 (see HERE), alternative executive pay frameworks may re-appear later in 2020, to be disclosed in 2021. The most likely forms, for some industries such as resources and banking cyclicals, will include time-vested equity grants deferred over long time period, but virtually guaranteed. Some may re-weight pay to non-variable elements.

Boards in these industries would be well placed to start assessments early.

Remuneration committees achieving something

A lament from many a remco chair is that at the end of a year they look back and wonder if they achieved anything. That is not to say they have not worked hard – equity plan rules, new offer conditions, performance scorecards, new recruit contracts, assessment and discretion – all have taken time on the agenda.

But that nagging feeling they have may often be right.

One of the obvious things identified by Commissioner Hayne was the fact that few boards ever ask if executive remuneration is effective. Does it have a purpose? Is it meeting that purpose? APRA as taken this on board with a requirement in the proposed CPS 511 regulation for independent remuneration effectiveness reviews at least every 3 years (see HERE) .

While it is early days, for those remuneration committees that have commissioned reviews, both the process and the findings have been well received. If anything, these remuneration committees now know what they want, and do not want. The bits and bobs that took up so much of their time in the past can be delegated to various control functions, or external assessment.

Independent remuneration effectiveness reviews are more likely in 2020 and beyond. We will see it in financial services companies first. The expense associated with an independent review may impede the trend at first, and so limit it to APRA regulated entities. However, it should spread to other sectors in future years.

Performance measures

More companies applied non-financial measures in 2019. This will continue in 2020, as companies come to grips with ESG, cultural, customer factors and other risk factors.

Most of these have no conclusive evidence of a causal relationship with revenue and profit growth, hence both boards and many investors are ambivalent. So we will likely see “compromise solutions” in 2020, and beyond, as companies have a bet each way, and modify traditional remuneration frameworks accordingly. These solutions will be suboptimal, and likely satisfy few. There are better frameworks than shoehorning more stuff into scorecards. We may see some of these in 2020.

Despite this, financial and market measures (i.e. TSR)) will continue to be dominant.

Board fee increases

In FY 2019 the average NED fee increase was 5.31% and the median NED fee increase was 2.46% (see article to be published for March newsletter). This is not dissimilar to executive fixed pay rates of increase.

Better a NED than an executive when it comes to pay? To answer that one would have to consider workload and personal risk. Maybe the answer to both is to ditch listed companies and look at private equity.

There is no indication that rates of NED increase will change significantly.

Executive remuneration increases

Last year CEO fixed pay increased 2.36% (see HERE) .

The wave of appointing successors internally has reverted to its usual standard. That is, while most appointments to executive positions have always been internal promotions, the trend increased in recent years as companies became risk averse following the GFC. Now, as capital markets appear to be making riskier bets, listed companies also take a gamble on external appointments to revamp some part, or all, of the company. This tends to push up executive pay rates, given the premium to persuade potential executive appointments to move.

The rate of increase for 2020 is likely to be similar, with an expected same-incumbent median fixed pay increase of between 2.2% and 2.5%. Within this, there will be significant variation by industry and company, with many not receiving any increases at all, and with the impact of bushfires and coronavirus, lower STI outcomes for many industries.

Demand for executive expertise will remain stable for the development and production job families in the mining and upstream energy industries, but less so in exploration job families.

Banking and finance is continuing to undergo significant change, with continuing high demand for technology, risk and control expertise, with pay rates fuelled by a low exchange rate and offshore imports.

Meanwhile, top bank executives look to a near future of having to pay down their own mortgages from fixed pay only, as short term incentives fade into a distant memory.

The technology sector will continue a good run in executive pay increases. Excess cash is still trying to find a home, and becoming less risk averse as it is splashed into technology companies willing to spend it on securing rare executive talent imported from offshore, with some local younger talent catapulted into executive ranks.

Similarly, plentiful cash is also being spent on infrastructure development and, eventually, operations executives.

Property sector executive pay will be more subdued. Within this, development executives will see some demand, but cost pressures reign on property operations as yields decline.

Executive pay across healthcare and education will be more subdued than in 2019.

Consumer discretionary and staples executive demand remains low, in line with consumer spending despite a recent uptick in retail.

Industrials executive pay is reasonably healthy. Communication services executive pay stalled in recent years, and despite the new technologies related to 5G being rolled out, will probably remain subdued.

Utilities executive pay will be subdued as energy generators and related industries suffer from poor returns.

As in past years, total remuneration including realised pay from vested incentives, will be aligned with financial performance on an overall basis.

Concluding remarks

2020 will be another interesting year for some board remuneration committees, while business as usual for others.

For many remuneration committees there will be “nothing to see here” as executive remuneration hardly moves, and some industries mark time. The hardest thing they may have to deal with is the extent they exercise discretion on otherwise poor performance outcomes arising from coronavirus “force majeure”. These days, such discussions will be brief.

For others, there will be enhanced consequence management, a focus on ESG disclosure, measurement and incentivisation, the beginnings of alternative frameworks that see “larger for longer” equity grants and the beginnings of a welcome focus on remuneration purpose.

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