The 8th annual Remuneration and Governance Forum, sponsored by Guerdon Associates and proxy adviser CGI Glass Lewis, was held in Sydney on Tuesday, 11 March 2014, at the offices of Allens Linklaters. The 2nd annual Perth Forum was held on Monday 17 March, also at the offices of Allens Linklaters.

Both events brought together participants with different perspectives on the executive remuneration and governance debate – including directors, institutional investors and management.

Feedback regarding both the Sydney and Perth Governance and Remuneration Forums has been overwhelmingly positive.

This article summarises what were full and absorbing discussions, albeit with many interesting bits left out because of the Chatham House Rule.

Executive remuneration

A range of views was expressed in the Sydney session considering the use of analyst forecasts to assess incentive plan performance hurdles. It was generally accepted that it is advisable for boards to at least cross check their numbers with analyst forecasts (noting that such forecasts have tended to be significantly higher than actual outcomes over recent periods). Nevertheless, incentive metrics and targets should remain subservient to the company’s strategic plan.

Analyst forecasts may be unsuited or irrelevant to companies that must think and act on investment decisions that live beyond the usual time frames encompassed by these forecasts, where the board requires internal rates of return “carved in stone” extending over seven or more years.

It was accepted that the board should have the discretion to ensure incentive outcomes reflect company circumstances, given that accounting measures can be unreliable for this purpose.

Relative TSR has the advantage that it adjusts automatically to market conditions and reflects shareholder value, but the thin ASX market makes it difficult to select good comparator groups. As no measure is perfect, a good approach is to use relative TSR in combination with an accounting measure (just as most ASX 200 companies already do).

Whatever measures are used, companies should explain why they are using them.

The Perth session focussed on the application of milestone incentives.

It was recognised that these were often suitable for companies in transition, whereby the transition will deliver substantial value if successfully navigated. However, there are design issues, including not being able to take into account elements outside of management control that may delay achievement, but not derail it.

In some situations the tried and true, if also flawed, TSR-based measures may better capture value creation because they automatically adjust to external factors that may make some of the milestones redundant or irrelevant.

In applying milestone measures, it was considered important that the board retain an element of discretion. This could also be applied to all-important considerations of safety.

Governance – board skills matrix

Whilst proxy advisors and institutional investors have been heavily focused on the improvement of remuneration governance in recent years, the investor spotlight is now turning to issues of board renewal and board effectiveness. Many investors are now utilising engagement sessions scheduled for a discussion of remuneration governance to discuss board renewal.

It was agreed that there is no room for passengers on boards these days; annual reviews are important to identify under-performance, and to allow directors to improve their contribution. As well, tenure guidelines help to ensure that succession planning is a continuous process.

Among several areas where boards need to improve was the absence of IT skills required to assess the risks associated with IT transformation and disruptor business models.

The increasing focus on board composition and director independence, skills and performance is reflected in the new ASX Corporate Governance Council Recommendation 2.2 requiring disclosure of a board skills matrix.

There followed discussion of the substantial benefits to developing and maintaining a matrix for the assessment of both current directors and prospective board recruits, and increasingly boards are interested in assessing the behaviours and capabilities that contribute to a high performing board (e.g. listening, building on others’ ideas, expressing constructive dissent) as much as the industry experience and technical knowledge the director may have.

Proxy advisers and many investors, as well as boards, are more intensely focussing on gender and diversity. Examples were provided of considering board recruits with no previous public company board experience but with fresh perspectives and technical knowledge. These included candidates with backgrounds in technology, private equity and Asia.

The need for post boomer generational change is driving the growing but still controversial acceptance of full-time executives taking on a non-executive director position.

The new skills matrix disclosure requirement will impact voting/engagement strategy, but is just one factor investors will look at, along with director workload (as measured by the number of board seats held by each director – which board will take priority in a crisis?). And board culture is dynamic, rather than static, with relationships between the chairman and management constantly evolving.

The challenge for company boards of the rise of beneficial owner activism

In a session exclusive to the Sydney Forum, participants heard that the increased focus on activism has been associated with a trend for investors to resume ownership rights from asset managers.

But with Australia’s shallow market investor activism does not mean there has to be a public battle – a collaborative and relationship-based, albeit less publically transparent, approach is usually utilised, with engagement sessions ostensibly on remuneration presenting opportunities to discuss a range of governance matters.

Surprisingly, it was largely agreed that activist shareholders help boards, because a board cannot run the company with shareholders’ interests in mind if the shareholders do not tell the board what they want.

However, it was also noted that many boards would find it difficult to engage if it was not for activists, as beneficial owners often do not disclose who they are, or what they want. To that end, in the absence of an Australian “stewardship code” the new (draft) Governance Institute principles (see HERE) are welcome to encourage better disclosure by institutional owners.

Proxy adviser data is being utilised by some activist investors applying sophisticated modelling techniques to identify and bring about board change.

First ‘strikes’ on the remuneration report often result from the communications gap between companies and their investors, with smaller companies, in particular, often lacking the resources for a full shareholder engagement programme.

Forums in 2015

While the expertise and deep experience in the room, and the absorbing nature of the discussions, fully justified the full house for the Sydney Forum, we are sorry we had to refuse those late in responding due to size limitations. Efforts will be made to ensure there are enough places next year, but we suggest you respond early when the invitations are issued.

The 9th annual east coast Remuneration and Governance Forum is planned for Sydney, possibly on Tuesday morning 10 March 2015 following the Labour Day holiday in Victoria and Tasmania. The west coast Forum will be in Perth, possibly on Monday 16 March 2015. Pencil these in, subject to confirmation in December 2014.

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