Appointing independent board remuneration advisers has been a major trend in OECD countries in recent years. Large listed UK companies have had to report remuneration committee advisers in their annual reports (although there was no requirement that they be independent), with additional information on fees and independence to be reported after the passage of the new legislation now being finalised in the UK parliament. The US Dodd Frank legislation (see HERE) has resulted in regulations requiring disclosure of advisers (whether these be compensation advisers, legal advisers, or any other advisers), conflicts of interest, and how these are managed. In Australia, poorly drafted laws require disclosure of board remuneration advisers (other than lawyers, accountants and actuaries) who have provided “remuneration recommendations”, and the fees received for these recommendations and other advice (see HERE)
As Australian board remuneration committees finalise plans for tackling a new financial year, many are considering the appointment of an independent remuneration adviser.
This article provides a checklist of matters committees should take into account when considering their independent adviser requirements.
1. Determine if you need an independent external adviser
A surprising number of boards still only receive advice from management. Much of the time this advice has been objective and competent, and informed with an intimate knowledge of company operations and business strategy. However, management’s ability to continue providing advice is constrained by the Corporations Act. They are no longer able to directly receive external assistance on executive remuneration matters in formulating advice to the board. That is, the Act now requires an external adviser to only send executive remuneration advice to a non-executive director. Check with your management that they are still able to provide you with the support you require.
While unusual, there have also been boards with at least one non-executive director expert in executive remuneration. While these boards may commission work to source market data, other advice is not required.
There have been instances whereby the board, with management’s concurrence, believes that no change to remuneration policy is warranted apart from conservative application of market increases. In such cases, this “steady as she goes” approach may indeed mean no external adviser is required. However, differentiate between a “steady as she goes” annual review and complacency. While your company may not feel the need to amend policy, your external stakeholders may have moved on. That is, what was acceptable last year may not be acceptable this year. So, to avoid surprises with remuneration report voting, make sure you actively engage with your shareholders and their proxy advisers. Otherwise, as added insurance, consider engaging an external expert to make you aware of any potential issues before they arise.
For the large majority of boards, however, the commissioning of external advice is necessary good governance. It serves as a cross check on conflicted internal advice that may be received. It positions the board as more truly independent when proxy advisers and investors ask them if they received their own advice. It is an insurance against being caught flat footed, or worse, in a fast moving legislative and governance landscape. And lastly, it can provide a fresh perspective for board decisions.
2. Manage conflicts of interest
Once you have decided that external advice is necessary, the committee may need to establish guidelines to manage the adviser’s conflicts of interest.
The most effective method is to establish a criterion that requires an adviser who is only employed by boards. If there is no potential that management could at some time employ the adviser, then no conflict arises. Conflict does arise even if an adviser does not currently work for management, because the potential for future management sourced fees is always there.
In a small market like Australia’s, the above criterion may be too restrictive, as very few firms are positioned as purely board advisers on remuneration. So the committee may have to relax its guidelines to a degree. For example, you may consider a firm that has the potential to earn fees from management. The more broadly based the services on offer are, the greater the conflict of interest. For example, a firm that can earn significant fees from tax, audit, recruitment, M&A, and finance has greater potential for conflicts of interest than a firm that just provides HR services.
The greatest conflict of interest arises whereby the adviser currently also advises management. A US congressional enquiry was able to quantify what this could mean in terms of egregious CEO pay outcomes (see HERE). The committee found a correlation between the size of fees earned from management and the extent that CEO pay exceeded normative standards.
Given this finding, the committee may either want to ban the adviser working for management, approve any work required by management, or set a limit on fees that could be earned from management.
Disclosing how the committee manages the potential for conflicts of interest may become a regular feature of remuneration reports after the government passes proposed legislation requiring a description of the company’s remuneration governance framework (see HERE). These disclosures are already a feature of US proxies, and make for interesting reading.
3. Seek out a vertically integrated service provider
Often good advice a committee has received has been lost in translation on implementation by management. This may be just an outcome of management’s interpretation of the board’s wishes, or worse. The best way to overcome the potential for a poor outcome is to ensure the board adviser has the capability to assist with implementation. This means a firm that has the research capability in market data, taxation, law, economics and finance for good initial advice, but also can assist in drafting equity plan and offer letter documentation, seek ASIC approvals, assist in engaging with proxy advisers, and prepare communications materials.
4. Make sure the primary adviser has the complete skill set – finance, economics, quantitative analysis, law, governance, and business sense
For sound advice today a remuneration committee may need to consider not only market practice, but also the taxation, legal, accounting, finance, disclosure, governance, and not least the behavioural implications of any change to executive pay. A top adviser needs to be across all these things, and link them to your business needs. In addition, the individual adviser, while having a good working knowledge, needs to be backed up by a team of experts in each of these fields. Your primary adviser needs to be well connected to ensure he/she is on top of what various stakeholders want. Importantly, he/she needs to able to focus primarily on the board’s business needs and how executive remuneration can be best aligned with them.
5. Experience in your industry
Industry knowledge is always useful in an adviser. What is the extent of option usage? What LTI performance measures are applied? What hurdle levels of performance do competitors have to jump? But with industry experience there is unease. In an oligopolistic market such as Australia’s this may mean an adviser has worked for competitors. Sometimes this cannot be helped, as a firm needs to work for a good proportion of the ASX300 to achieve the economies of scale to provide the breadth and depth of services you may need. While there may be some heartache involved in using a competitor’s adviser, the likelihood is that your own company is in an entirely different place. No two companies are the same, so it follows that variations in remuneration strategy between two competitors makes sense. So, overall, it is probably best to seek experience in your industry rather than an adviser who has none.
6. A consulting process you are happy with
Ask how the consultant will deliver the work. While the Corporations Act requires the adviser to deliver advice only to a non-executive director, do not consider a consultant too timid to engage with management. To ensure robust advice, the consultant should be aware of the operational and strategic issues from management’s perspective. Look for an adviser who seeks this out.
If this is the first time you will have appointed an external adviser, be aware that there may be a rocky road with management who feel shut out of pay deliberations. To minimise the possibility of dysfunctional management behaviour, assess the consultant’s ability to diplomatically engage with management during the journey.
Remuneration committees also vary considerably in experience and expertise in executive remuneration matters. Seek out an adviser who can adapt his or her style to ensure all committee members are on the same page, and can communicate clearly the complexities of an issue that was once an operational matter when it is elevated to board level.
7. Know what engaging an adviser means for your own workload
An experienced board adviser will generally know how limited your time is. He/she will be able to provide you with an idea of the process where your input and engagement is necessary. He/she will also try and make your job easier by bringing management along on the journey, so that you as a committee are not left to justify to management the complexities about going down a path that you have already travelled. But nevertheless, the process of hiring an external adviser will mean a bit more work, especially by the committee chair. This is the inevitable outcome of heightened governance expectations. A good adviser will not shy away from this fact, but provide you with a degree of confidence that he/she will make it as painless as possible.
8. A point of view
A good adviser will keep you out of trouble. Occasionally this will mean someone telling you something you may not want to hear. As a committee you will need to judge if the adviser has the combination of independence, integrity, communication skills, diplomacy and assertion to be effective in this regard.
However, once having made the point, he/she will need to be a problem solver and flexible enough to work through with you what you want.
It is the nature of consulting that the workload is high, and the hours are long. Check that your adviser will be available when you want him/her. How many clients does he/she personally handle? What about evenings and weekends? To what extent is he/she travelling and unavailable? In the event that he/she is unavailable does the firm allow for an equally senior support person across your issues?
10. Peer review and quality
Explore what the firm’s quality control process is. Do they have a disciplined peer review process? How does this work?
For most ASX listed companies, engaging a board remuneration adviser is good insurance. But not all advisers are equal to the task, or will have the right elements for good chemistry with both the board and management. In addition, the potential for a conflict of interest is very real. Lastly, engaging an adviser means one more input to a board’s decision making process already groaning under the weight of governance requirements. So the key takeaways for a remuneration committee considering an adviser appointment is to perhaps review and weight our checklist for what is important to you, while bracing yourselves for one more increment in your workload.© Guerdon Associates 2023 Back to all articles