Guerdon Associates and CGI Glass Lewis sponsored their eleventh annual Governance & Remuneration Forum in Melbourne and Perth in early March.
The 2016 AGM season was a torrid affair with both investors and boards recognising the loss of trust and respect.
The 2017 Forum was focused on halting the erosion of trust between boards and investors by drawing out the different perspectives to facilitate a better understanding. The themes of the Forum were:
- Complexity, connivance or competence – the loss of trust between investors and issuers on executive remuneration
- ESG ratings and their impact on the value of issuers
- The impact of NED independence, or lack of it, on issuer performance, value and governance
The Forum’s objectives included:
- Enabling corporates to better understand and effectively manage remuneration and governance issues with institutional shareholder support
- Assisting institutions to gain insight into, and influence over, governance structures/policies, board renewal and executive remuneration for better alignment with shareholder interests; and
- Ensure regulators recognize the need for compliance burdens to facilitate better and cost effective governance
While the Forum continues to be held under the Chatham House Rule, the key points of discussion and debate that emerged can be shared (without attribution other than those of CGI Glass Lewis on its proxy advice). You should recognize this is a summary of the discussion points, reflecting a diverse range of views from participants. They may or may not have validity.
CGI Glass Lewis on 2016, and looking at 2017
CGI Glass Lewis is happy to share its approach in 2016 with subscribers to our Guerdon Associates Newsletter.
The key findings of CGI Glass Lewis’ review of 2016 could be summarised as:
- Significant shareholder frustration. While 18 strikes in the ASX300 is not the highest since introduction of the two strikes rule, it was an about-turn from the decreasing trend since 2013.
- High remuneration levels were a significant focus of investors. (GA comment: This is an important change in emphasis. In prior years the focus was on rates on increase. Now there is significant focus on absolute levels of pay. The general feeling, despite 5 years of declining CEO pay, is that absolute levels are too high)
- The increased complexity and decreased transparency seemed, in their view, to be a big contributor to the shareholder frustration.
An important pointer to investor behavior is that CGI Glass Lewis recommended against 17 of the 281 remuneration resolutions in the ASX300 but only 5 of those received a strike. This shows that many investors are using the proxy adviser reports for reference but reaching their own conclusion on the remuneration report. It also points to the need for issuers to ensure they are being transparent and are communicating their narrative with clarity. (GA comment: It also says that the nature of engagement extend beyond the proxy advisers into major investors in a more concerted and systematic effort than in the past.) There have been cases of investors forming a poor conclusion during the time-pressured heat of the season – equally the fault of the issuer for poor communication, and the investor for lack of complete diligence.
What to expect in 2017? CGI Glass Lewis’ focus in 2017 will include:
- Board skills matrix: not merely the disclosure of it, but rather, the relevance of the skills to the business and its strategy. CGI GL is looking to see whether boards have thought about the skills required and are doing something about it, or whether they are simply ‘ticking the box’ by having a skills matrix and describing it.
- Diversity in the executive KMP ranks: CGI GL’s reports in 2017 will include their analysis of changes in diversity at the executive KMP level, whether the company is a member of the 30% Club, and what initiatives are being undertaken to increase the number of female executives.
- Director independence: CGI GL will continue its focus on NED independence with an even closer scrutiny of related party transactions.
- Remuneration reports revamped: when companies use relative TSR in their LTI plans, CGI GL wants to see the remuneration report explaining the relevance of TSR for the company and in the context of its strategy. CGI GL would also like to see companies revamping their remuneration reports to be clearer, shorter and less confusing.
- E & S: CGI GL is in a partnership arrangement with Sustainalytics Inc, a global responsible investment research firm specialising in environmental, social and governance (ESG) research and analysis. CGI Glass Lewis will continue its focus on how companies and boards are managing their environmental and sustainability issues.
Impact of ESG integration on issuer value and returns
The debate and discussion of ESG integration highlighted the concept that ESG is regarded by investors as a proxy for management quality.
Investors are increasing their scrutiny of management’s approach to ESG as a tool to assist them and inform their investment decisions. On the basis that share prices are a function of earnings and earnings revisions, investors will have a preference for companies with quality management delivering sustainable earnings.
Investors are using the “ESG lens” as an indicator of the longer term implications because it gives them a more skeptical and qualitative analysis of the business and management quality.
Not surprisingly, the Melbourne discussion considered the recent focus on corporate approaches to culture, customer satisfaction and staff engagement with a consensus view that most of these non-financial matters are critically relevant.
The Perth discussion focused on the impact of poor E&S assessments on company value, and what companies can do to correct assessments that are not valid.
It was recognized that a significant aspect of ESG integration is an understanding by both companies and investors of the ‘timing factor’. Some ESG issues may be perceived to be so long term that the impact in the short term is overlooked (consider, for example, climate change or driverless cars).
A concern was expressed that many of these issues have led to company boards to become so risk averse that they have lost any sense of an entrepreneurial spirit. There is a sense that companies, led by boards, are acting as though they no longer have a right to make a mistake.
This was said to have risen from the general loss of trust in boards experienced over the last eight years or so.
The views put forward to address this included the need for boards to comprise directors with commercial nous, who therefore knew how to balance entrepreneurial activity with risk.
Remuneration: too complex or too sneaky by half?
That loss of trust emerged again, or rather, we were reminded that remuneration matters have been considered a significant factor in the loss of trust.
The discussion from institutional investors was that they expected to see rational outcomes in pay and that it would not be expected to vary significantly from year to year, or relative to the company’s performance. If it did vary, or the outcomes do not appear rational, institutional investors want to see, and be able to understand, the explanation for this.
There has been a sense that remuneration is too sneaky by half when investors and proxy advisers read a company’s remuneration report and cannot understand what the board is doing with the remuneration framework, nor why they are doing it. Their view is that there is no clarity in the explanation.
It was recognized that directors feel they need to respond to the competing demands of investors and the proxy advisers, as they all have different guidelines and preferences. It was suggested from the audience that this has led to the common remuneration frameworks typical in the market.
One view was that these common approaches are not effective, and could be done away with. The STI structure was said to be virtually guaranteed and did not guarantee commensurate corporate performance. Hence, it could be removed and replaced with a level of shares contingent on longer term performance.
The view that institutional investors and proxy advisers often perceive STIs to be “fixed pay in drag” was countered as an oversimplification of the analysis of the framework and its purpose. This counter view helped participants to understand that such STI structures are designed to reward for consistency and sustainability of earnings. Investors should not want volatility in the earnings (and, consequently, in the remuneration).
There may be some complexity – but it is for a reason! And the counterview suggests only those who do not understand the complexity of the business, its drivers and what is being asked of management will regard it as sneaky!
Another view was that ever-increasing remuneration levels could be halted as remuneration is not generally high on the list of factors motivating senior executives. A question for the proponent of that view went to the heart of the public disclosure issue – how does a board pay its management team significantly less than what others in the market are seen to be getting?
The highly-charged discussion brought out the desire for innovation in remuneration structures, if only to demonstrate that thought is being given to the company’s strategy.
Director independence – time for a different approach?
The great debate, as expected, generated some polarising views including from the audience.
Investors are looking to directors to deliver wealth creation. Institutional investors believe this comes from well-informed directors, with commercial nous, who are not captives of management and have skin in the game.
There were strong views that this can only come from directors who are truly independent, are not related parties and not simply significant shareholders with a lot of skin in the game.
It was suggested that a company board could be comprised of all independent directors meeting the prescriptive requirements, but would add little or no value to the business as they are often ‘captives of management’ and guilty of groupthink.
The minimum shareholding requirements and professional reputation were not considered to create enough ‘skin in the game’ .
Mark your calendars! Next year’s Forum will be is Sydney, possibly on the 8 March and again in Perth, possibly on the 13 March.© Guerdon Associates 2022 Back to all articles