Guerdon Associates hosted a Directors’ Briefing webinar on 26 November featuring Martin Lawrence, co-founder and Director of Ownership Matters (OM), a leading Australian proxy adviser.

This summary highlights the key points coming out of the discussion.

OM’s guidelines

OM does not have prescriptive guidelines for its assessment of issuers’ remuneration frameworks. This is intentional as OM believes the best approach is to review a company’s remuneration framework, remuneration report and equity grant resolutions having regard for the business, its operational complexity and other relevant factors.

The issues attracting OM’s attention this season?

Calendar 2024 looks like matching or exceeding last year’s record 41 strikes. One of the reasons is likely to be companies having difficulty in this low-growth environment to adjust remuneration to reflect performance.

Proxy advisers and institutional investors do not generally consider downward adjustments to variable pay sufficiently reflective of poorer than expected corporate performance. That is, the downward adjustments indicate the board has recognised the issue and made a negative adjustment to variable pay, but the negative adjustment has not been large enough.

So, what level of adjustment is enough? OM’s view is that at-risk remuneration means it can go to down to zero. When putting this to board directors, OM is told that it is not about the loss of incentive but rather, the non-monetary message sent by a zero outcome. Executives consider a zero incentive outcome is a black mark, and sends a message to the market damaging the executive’s future employment prospects.

For OM, there is a lesson from this. If variable pay is to be regarded as truly at-risk, it should reflect the corporate (and individual) performance. Boards will be ‘marked down’ if they do not recognise this.

Similarly, management must recognise that they are accountable for performance, and the outcome of their at-risk pay should be in line with the company’s performance and shareholder experience.

The source of concern is mainly annual performance incentives, not long-term incentives (LTIs).

OM views LTIs as basically set and forget. OM generally does not expect to see adjustments to the LTI outcome.

Short-term incentives (STIs) are where the board should more frequently apply adjustment to formulaic outcomes.

OM has no problem with board discretion being exercised, provided it is proportionate.

While OM’s views on expected variability has been a surprise to some, OM are also ok with positive discretion being applied. Boards can gain investor and proxy advisor trust if their historical actions reflect negative and positive adjustments that are appropriate for the particular circumstances.

In simple terms, OM’s view is that management should expect to ‘take the rough with the smooth’.

A general comment made was that investors are recognising that the remuneration report vote is a powerful tool for them to send a message to company boards.

Pay levels and structures for overseas based executives

Some ASX companies are global. Boards need to recruit executives from the global talent pool. One of the most obvious examples of market differences is the high level of RSUs (or restricted shares) paid in the US that is not readily accepted in Australia.

Another example is the high levels of grant value in the US compared to Australia.

The ASX 100 has more than 10 global operators with executives resident in UK, North America and Europe.

OM acknowledges the issue of recruiting talent from the global pool can be difficult given the different pay levels and structures, and has some sympathy for this. However, if a company has a primary listing on the ASX and is Australian-incorporated, OM’s view is there are benefits to being in the Australian market. It is not just the global pool comparison.

For example, the point was made that while Australian companies may seek to recruit US executives, it is not common to see Australian executives lost to the US or other global markets.

Companies with a secondary listing on the ASX due to an acquisition, are not viewed against Australian standards. OM gives these companies more “slack”.

Significant cultural issues

The past year has seen a range of significant cultural and governance issues across ASX 200 companies not all of which have been founder-led.

When considering these matters in the context of its assessment of the remuneration report, OM considers two things:

1. Is the remuneration report contaminated by the cultural issues? For example, did an individual involved receive an incentive? Did it happen on their watch? If yes, OM may recommend against.
2. Has the board/company recognised and dealt with the issue/s? That is, have they “got it”? Is the board in the process of cutting out the contamination? If the remuneration report is not contaminated and sufficient remedies have been/are being enacted, OM sees little point in recommending investors vote against the remuneration report.

An interesting part of this discussion was the observation about culture when the board was being advised of OM’s recommendation to its clients to vote against the remuneration report and/or equity grant resolution. The board response was generally indicative of whether a good culture ran through the company, or otherwise.

Institutional investors advocating for RSUs?

There have been instances of institutional investors (like Norges) advocating for service-based equity vesting after a minimum of 5 years and preferably up to 10 years.

OM considers unhurdled equity as fixed pay. In OM’s experience, unhurdled equity (like RSUs) are implemented when the hurdled LTI has not been vesting.

Nevertheless, OM sees that RSU grants have some utility for alignment. When transitioning from a hurdled LTI to RSUs, OM expects as a minimum a 50% discount to the value of the hurdled LTI opportunity. This is the trade-off for the near certainty of vesting.

The discussion moved to dividend equivalents. OM does not have an issue with dividend equivalents. They would rather it be paid as a dividend equivalent at the end on vested instruments rather than a discount to the allocation.

Minimum shareholding requirements

The discussion on minimum shareholding requirements (MSR) focussed on what is included for that purpose and timeframes for accumulation.

It was noted by OM that some companies had a policy of including the value of unvested LTIs towards the MSR. Such policy would not be acceptable.

OM will accept a policy that restricts disposal of vested equity until such time as the MSR is met without specifying an accumulation period.

The government’s report into the consulting firms?

OM’s view is that conflicts exist and they are hard to manage. But, they should be recognised by the board and processes in place to deal with any potential conflicts of interest.

One of the best things a RemCo chair could do is to ensure they have access to investors outside of management channels. Being aware of market sentiment is important.

An interesting part of this discussion was the expectation that following the change of government in the US, there is potential for action against the major proxy advisers in the US. While there has been no further regulatory action against proxy advisers in Australia since that of the coalition government in 2022, it is reasonable to expect that Australia may follow the US if the proxy advisers come under regulatory attack.

Cyber risks and how they are reflected, or not, in incentive frameworks?

It is recognised that cyber risks and failings are best captured in the incentive framework as a gateway condition rather than reflected in the scorecard or similar.

OM views it as a gateway condition or board discretionary adjustment being required. A simple test for boards is to consider how it would it look if incentives were paid when there was a significant adverse impact on customers?

Balance of financial to non-financial metrics in STI plans?

OM views non-financial targets as neither good nor bad. It depends how they are adopted and implemented. There are often as many soft financial metrics as there are soft non-financial metrics.

The most important aspect, in OM’s view, is the board’s ability to sense check the outcome, rather than the weighting between the two.

One of the bigger issues for OM, and becoming more evident, is that boards have no difficulty in setting sufficiently stretching performance requirements for maximum vesting. The issue for OM is the threshold and target level of vesting. The threshold at which 50% vests is often at the same level as the prior year, or even lower. The fundamental issue for OM is the threshold is often too easily achieved and they are not seeing any level of growth or stretch.

Threshold and target vesting are where the directors’ independent relationships with investors and sell side analysts can be useful to gauge market expectations.

OM’s view is that target vesting should reflect guidance and that no more than 50% of maximum would vest at target.

The message for boards is to understand the market’s expectation of performance and the rationale for that expectation. And set threshold and target vesting accordingly.

The benefit of battle-scarred Directors

Are directors more useful because of the experience they have gained or no longer suitable for company boards? OM’s view is it depends on the issue and their legacy.

The discussion turned to overboarding of directors. A range of examples were provided that include circumstances where corporate transactions can be underway in two or more companies at the same time and on which there is a common director. The demands on the director’s time and intellectual capacity can result in the company not being served in its best interests.

There is a point when the number of board seats is too much. However, it does come down to the nature of the company boards, and the individual.

Climate Report in the Annual Report from FY25.

As companies will be required to include extensive climate disclosures from FY25, OM was asked what emphasis, if any, it will be placing on climate-related KPIs in STIs and LTIs? What metrics will OM be looking for in respect of transition plans in the STI that support more objective measures in the LTI?

For OM, it comes down to materiality. So, for example, if an oil and gas company makes little or no significant disclosures on climate risk, then something is wrong.

OM considers that, as a bare minimum, it needs to be apparent that the board is appropriately requiring management to manage the risks to the organisation – energy supply, energy risk, physical risks, actual costs of carbon, among others. These will not be a big deal for many companies, but will be for many others. See, for example, the steel manufacturers, given the agreed need for steel, that need to find a way to make it “green”. The carbon transition is critical, they are energy intensive, but as it is not clearly known how the problems will be solved, it is equally difficult to incentivise management.

 

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