A sense check needed

For 2 decades we have observed the ever increasing avalanche of pay regulation, investor requirements and proxy adviser guidelines; boards’ reactions and, perhaps too often, their submission to strictures contributing to vanilla pay for all, ho-hum performance, loss of talent overseas or to private equity and, consequently a paucity of new listings and exits from public markets. Our firm’s annual GECN Group leader’s meeting, this time held in Sydney, Australia gave us further insight as to how our overseas peers are addressing this, and increasing their market leadership as competitors for talent and capital.

This was also evident at our annual Remuneration and Governance Forum. We have been reflecting on some of the topics that led to debate and what boards can do about them.

Are incentive opportunities being valued correctly?

There exists a disconnect in how the quantum of variable remuneration is perceived. Executives, and overseas proxy advisers and investors, tend to anchor to target remuneration while uniquely, Australian investors and proxy advisers anchor to maximum opportunity.

Yet in the ASX how often do we see outcomes at maximum? In the ASX 100 over the past three years, only 10% of CEOs have achieved an STI outcome of between 91 – 100% of maximum opportunity. See HERE for more detail.

This suggests a deeper issue in the ASX market. It is difficult to believe that only 10% of CEOs are delivering performance that merits an STI outcome of above 90% of maximum. It raises the question of whether current frameworks are sufficiently rewarding outperformers, or if ‘target’ has become the new standard of success for executives.

Investors and proxy advisers are not likely to move away from their focus on maximum without a big and concerted nudge. The responsibility is therefore with boards to consider and communicate polices based on target, and hence likely pay, and make provision for outsized rewards for delivery of material outcomes delivering substantive shareholder value.

Restricted stock. Shouldn’t investors be pleased that management receive payment in stock rather than salary?

Although restricted stock is growing in prevalence, some proxy advisers, including ISS, are opposed to restricted stock on principle citing a lack of ‘performance hurdles’. This is a conflation of the payment vehicle with payment requirements. They are independent. That is, what are we paying for – service by the hour, year or decade; or performance by the tonne, women in management, $ in profit or market value? Then, how do we pay for it – in cash, stock, options, or more annual leave? While investors and boards believe that measuring and paying for performance is highly desirable, often times it has unintended or unavoidable consequences. In these cases balance the potential for negative consequences by paying in long term deferred stock. And, while executives like cash, it may be in short supply for high growth or start up companies, so stock is a better way.

As we have outlined many times before, boards should consider whether restricted stock is right for the company, rather than fear dissent from proxy advisers applying a rigid application of guidelines.

The challenge for boards is to determine if “skin in the game” through restricted stock provides a better driver of long term success than performance based LTIs. If so, then implementation requires strong strategic rationale and clear investor engagement.

The two strike rule – is it stopping the ASX compete?

The two strike rule is unique to Australia. As shareholders are becoming more comfortable voicing their dissent (see HERE for more detail) and opposing remuneration through voting, is it what is holding Australia back?

The two strike rule constrains aspirations. Boards are much more likely to opt for conservative pay structures and risk averse strategies to avoid a strike by a minority of shareholders.

While intended to increase accountability, the rule has arguably created an overly compliance focussed mindset that discourages tailored reward frameworks and as a result limits the higher returns seen in other markets.

But what are the alternatives? In other markets, including the UK, directors stand for yearly elections. This could provide greater investor control and facilitate the retirement of the two strikes rule. Lately, we have seen greater UK board tolerance for higher remuneration report “no” votes as they work to reverse the UK’s flagging company performance and capital markets, without, as of yet, much impact on director elections.

As is the narrative throughout, boards need to do what allows the most effective executive attraction, retention and results focus, communicate why, and trust that the strength of the rationale maintains the support from the majority of their investors.

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