A board remuneration committee checklist for executive pay market review red flags

The Australian Council of Superannuation Investors (ACSI) did score a point when they released their review of ASX 100 CEO remuneration last week (see HERE). They said that there have been several examples of companies providing large increases on executive fixed pay without adequate explanation.  They are right.

This is contrary to Corporations Act 300A requirements (see HERE).

So what should be provided in directors’ remuneration reports that would demonstrate compliance with the Act’s requirement that “The directors’ report for a financial year for a company must also include (in a separate and clearly identified section of the report)…discussion of…board policy for determining, or in relation to, the nature and amount (or value, as appropriate) of remuneration of the key management personnel for the company”?

At a minimum, it should probably include a description of the peer group/s used for setting executive pay.

Perhaps one of the better guides for directors comes, from of all places, one of the rating agencies. With the credit squeeze debacle, credit rating agencies are not to everyone’s taste at the moment. However, they sometimes provide useful pointers in examining sources of risk.

In this regard Moody’s recently identified red flags regarding executive compensation in a new analysis of the US SEC’s expanded disclosure requirements that we suggest could be used by Australian company remuneration committees as a checklist. Their disclosure requirements have been interpreted as requiring companies to list the peers used for benchmarking executive pay. This level of disclosure could form the basis of compliance with the Corporations Act requirement noted above. Indeed, several well regarded ASX listed companies do this voluntarily.

And even if not disclosed in the remuneration report, Australian remuneration committees could use these guidelines as an internal checklist that they are getting the market comparisons for determining executive pay right. Of particular note are Moody’s comments on how companies can “game the system” when benchmarking executive pay against peers.

Moody’s lists the following red flags to look for when assessing peer groups:

  • Too many companies listed (more than 15)
  • Bias toward “peers” that are substantially larger and/or more profitable
  • Multiple peer groups with unusually high CEO pay, particularly if not direct competitors
  • Too many industry markets included
  • Peers that do not compete with the company for executive talent
  • Unexplained year-to-year peer group changes

These red flags can be a concern to investors because of the potential to “game” the pay-setting process.

For example, Moody’s says, a company may select a peer group composed of companies that are substantially larger than itself; that set a high percentile pay target (75th percentile or greater); or that operate in a more profitable sector. This practice can indicate an undisciplined pay-setting process and weak board oversight.

That said, some Australian companies have provided useful peer group disclosure, including key factors about the peer group like revenues and asset size.

© Guerdon Associates 2024
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