On 18 May, Guerdon Associates hosted a Director’s Briefing webinar featuring Martin Lawrence, Director of Ownership Matters (OM). Ownership Matters is an independent governance firm providing proxy advice to institutional investors in Australia including via the Australian Council of Superannuation Investors (ACSI). The views expressed in this summary of the Briefing reflect those of Ownership Matters as per the Briefing.
OM is not prescriptive in its approach and will review a company’s AGM resolutions having regard for the business and relevant factors. Notwithstanding, areas of focus for OM in the upcoming proxy season include:
- Pay and performance: given the lingering effects of COVID-19 and the challenges faced by companies due to reduced demand.
- Shareholder resolutions on climate change: institutional investors have considerable interest in climate change and its impact on a company’s value.
Financial services companies are continuing to come to terms with APRA’s CPS-511 and its requirements on material weight being given to non-financial measures in incentive plans.
- Following the findings of the Financial Services Royal Commission APRA expects regulated entities with variable pay to have a material weight of that variable pay contingent on non-financial measures. It was observed that while the major banks were already doing this, it did not seem to prevent much of what the Royal Commission found. The issue, at least for OM, would appear to be more related to the enforcement of scorecards, rather than the scorecards themselves.
- APRA views total shareholder return (TSR) negatively. OM suggests there is an argument that TSR be considered a non-financial measure since management’s ability to influence it in a sustainable way diminishes over time. APRA, not surprisingly, does not share this perspective.
- OM understands that APRA considers market share to be a financial metric. OM would suggest that market share is a non-financial metric as it is a function of a focus on customer retention and growth.
OM expects boards to exercise malus, clawback and board discretion provisions when the circumstances require and it is expected by investors. The view is Australian boards tend to exercise discretion in appropriate scenarios, although the magnitude of the adjustment may be inappropriate.
When assessing pay-for-performance, OM strives for objectivity. The focus is placed on stretch and maximum performance measures. Companies consistently awarding incentive outcomes at maximum level suggest that target and maximum setting by boards may not be as rigorous as would be expected.
There is general scepticism regarding positive discretion in remuneration being exercised. OM can understand discretion being exercised around STIs but has greater concern when discretion is exercised on LTI outcomes. Their rationale being that there should be enough time to react to the external factors during the performance period for the LTI.
- There can be justification for the exercise of discretion on the STI scorecard when there has been a significant negative external event.
- An unreasonable exercise of discretion would involve vesting the LTI when threshold criteria were not met and without providing justification. LTIs should align with the shareholders’ experience.
OM identifies the following emerging innovations in remuneration and governance:
- Reducing the weight of STI and increasing fixed remuneration through an equity grant that vests over time. This model reduces upside and may be suitable for companies with extended business cycles where the success of the current management team is contingent on prior management and is not immediately realised.
- Non-financial performance measures are increasingly incorporated into LTIs, including strategy (which OM is sceptical about) and carbon-related metrics.
- Annual director elections though OM is neutral.
- Increasing tendency to benchmark against US market remuneration that is significantly higher than Australian remuneration. Such market comparisons should be confined to companies with significant operations in North America and locally domiciled executives.
- Major transformations requiring substantial expenditures might be expected to adopt a remuneration framework heavily weighted to equity.
- Boards should be demonstrating their consideration of cybersecurity in governance disclosures.
OM is less focused on gender diversity than other proxy advisers and will consider a lack of female board representation in its overall assessment of the company’s governance. There is a lack of age diversity (i.e., limited number of directors under 50) and geographical diversity (expectation of companies with global reach having directors from regions in which it operates).
OM’s views on underperforming companies include:
- Recognition that a return measure may need to be set below the weighted average cost of capital (WACC) or cost of equity when a company is in recovery mode. Noting, of course, that if the management team remains the same through the down and recovery periods, the measures would be assessed with scepticism.
- Outcomes that align with guidance are acceptable. Results do not need to show continuous growth.
Carbon abatement should be incentivised for companies with significant emissions. However, incentives tied to carbon abatement for the sake of it in a company without significant emissions concerns do not make sense.
It is challenging to assess whether targets are sufficiently challenging. Climate-related measures should not be implemented solely for the sake of having them.
Overcrowded scorecards lead to a situation where everyone gets a prize. If an element is considered important, it should carry a weight greater than 5%. A scorecard with fewer elements is preferable, allowing for discretion in cases of negative events, both in the financial and non-financial spheres.
The remuneration framework for large companies operating in defensive sectors or oligopolies may be different. Maintaining the current business may be more important than growth. Less ambitious performance targets and a lower total remuneration package may be more appropriate. Management will be remunerated as stewards rather than entrepreneurs.
Observations on performance measure include:
- Earnings Per Share (EPS) as a primary measure is closely scrutinised because it can be easily manipulated through debt-backed acquisitions.
- Companies with a history of workplace fatalities should incorporate safety measures into their remuneration frameworks.
- Absolute TSR is not considered a reliable performance measure as vesting can be influenced by market factors.
- Relative TSR is the “least worst” LTI measure. However, creating a peer group for unique companies can be challenging. OM does not contend that Relative TSR is a necessary component in an LTI framework.
With regards to SARs and options:
- OM still considers them an appropriate equity vehicle provided they are contingent on measures other than simply the exercise price
- A growing company deciding to eliminate SARs or options prematurely is a cause for concern.
- SARs and options may not be suitable for larger, more stable companies.
Ownership Matters maintains an open-door policy and encourages discussions without blackout periods.© Guerdon Associates 2024 Back to all articles