It has been a demanding 12 months for board remuneration committees. FY 2020 is unlikely to be easier, with: APRA’s review of CBA, and then 12 other companies in 2018; the Hayne Royal Commission into financial company misconduct; the Sedgwick review of sales incentives in financial services; a prospective Labor government’s new pay regulations; the current ASIC task force reviewing non-financial risk and remuneration; a new prudential remuneration standard to be issued shortly by APRA; ACSI’s new guidelines for remuneration and disclosure; investor dissatisfaction with board’s oversight of executive incentive payments; and changing proxy adviser perspectives on director election recommendations.
As remuneration committees reflect on their accountabilities, we offer the following 4 FY2020 committee checklist priorities:
1 . Be Ready for An Expanding Remuneration Committee Role. Think CEO Pay Ratio and gender and other diversity-based pay inequities, “front-line” remuneration, talent development, and culture-related concerns are pushing the boundaries of traditional remuneration committee responsibilities.
2 . Get More Comfortable with Non-Financial Metrics. They are now front of mind in the financial services sector but are present in every industry, a robust discussion on the subject should be included in your 2020 remuneration committee’s agenda.
3 . Be better at assessing and paying for performance. Be prepared to explain the ‘why’ around everything from the remuneration strategy and structure to the incentive outputs, including why or why wasn’t board discretion exercised. A thorough assessment of risk including non-financial risk and poor risk behaviours and outcomes may become part of the assessment of performance pay.
4 . Expect and Test for Unexpected Impact to Your Remuneration Plans. Remember good plan design—and good executive remuneration governance—includes planning for the unexpected. Inevitably (as discovered during the Hayne Royal Commission) there will be things that you have not fully anticipated, but thoughtful preparation for the “known unknowns” and brainstorming “black swan” events can help the board mitigate future risk.
Be Ready for An Expanding Remuneration Committee Role
One of the most consistent trends seen in corporate governance over the past four years is the expansion of “executive remuneration” committee oversight, the title “remuneration committee” increasingly a misnomer.
Expanded oversight now includes succession planning, corporate culture, risk management in remuneration design and application (malus) and diversity. Boards are now beginning to understand that these human capital issues present real, strategic business challenges, risks, and opportunities to their companies. Many investors expect disclosures in the governance report to describe progress in achieving quantifiable objectives on diversity, culture, and succession.
- Succession Planning and Talent Development: CEO succession has long been one of the key responsibilities of the board. We see leading boards expanding their purview beyond an annual “ready-now/ready-soon” review of successors to key positions tilted too heavily towards the status quo to focus on the needs of the future. For example, some committees have moved to alternative succession chart(s) that contemplate i) the actual expected timing of retirements, and/or ii) changes in business/organizational needs underpinning the business strategy. These alternative views can highlight talent development or recruiting needs not just in the ‘C’ suite (e.g., ready-now executives who will be past their “expiration dates” when positions are likely to become open, or skills/experience gaps in the current management population needed to meet the changing business) but across the entire business.
- Corporate Culture and Employee Engagement: Corporate culture is a bit like art—we may disagree about what is good, but we all know bad when we see it. Historically these issues have been squarely in the no-fly zone for directors unless or until there was a major problem. Today a good proportion of ASX 100 directors are worried enough that that they do not know if they have a problem to want to do something about it and board committees are looking to be more engaged. The recent examples of the impact of negative business practices resulting in poor customer and reputational outcomes have convinced many directors that oversight of culture is just as important as oversight of business operations/strategy – good intent in policies and processes does not always result in right actions by employees. Committee oversight tends to take the form of monitoring trends and reports (e.g., engagement surveys, employee turnover statistics, exit interview findings, Glass Door reviews, etc.). In addition, many directors try to develop a better understanding of the corporate culture through individual efforts and activities (e.g., attending employee town hall meetings, “wandering the halls” before and after board meetings, individual site visits, etc.). This will not be enough. While different business units, functions, and locations may require unique behavioural norms to be successful, some behaviours need to be normative across the company (Commissioner Hayne’s admonition to “obey the law” comes to mind as being applicable to all companies and all employees, for example). Committees need to identify what are the required company-wide behaviours and ensure management roots out and remedies non-complying behaviours, business practices or products monitoring, analysis of risk incidents as well as the trends in customer, regulator and whistle-blower feedback. The list will not be long, but there is work to establish it, and then ensure there are systems to monitor and enforce it. This is the 2020 task for many committees.
- Diversity: For many boards, their diversity discussions started a decade ago with the committee having a responsibility to ensure that the company has policies and procedures in place to address shortcomings and take remedial action as necessary. Companies increasingly recognize the advantages to being viewed as a leader on diversity and inclusion issues and having a board and employee profile more reflective of their customers, communities and markets. At a broader organisational level, a reputation as an open and inclusive employer can be a competitive advantage in a tightening labour market. And more and more, consumers are considering good corporate citizenship as a factor in their buying decisions.
Practically speaking, the challenge for committees is making time in the annual calendar to address these issues in more than a check-the-box way. As companies look to ensure that emerging strategic human capital issues get the appropriate attention, committees could identify opportunities to streamline the more compliance-oriented parts of the annual agenda. Simple things like executive summaries, materials in advance, and consent agendas can help to free up precious time for important strategic discussions.
Getting More Comfortable with Non-Financial Metrics
ASIC and APRA are asking companies to expand performance criteria beyond traditional financial yardsticks which is not embraced by all (see Ownership Matters opinion piece HERE) .
It is challenging but if done correctly, the resulting balance of both lead (non-financial) and lag (financial) metrics may provide a more holistic framework to motivate and reward long-term performance. The top questions to ask when starting down this path are:
- Which non-financial metrics should be considered and for what incentive program?
- Should non-financial metrics be a separately-weighted component or a modifier?
- What are the potential pitfalls in implementing non-financial metrics?
- With multiple financial and non-financial measures in a balanced scorecard, how can incentive pay be variable enough to meet investor expectations?
- What non-financial metrics are meaningful and material to value?
- What must be done to receive investor support and trust that non-financial measurement can be as robust, objective and demanding as alternatives, such as relative TSR?
Be better at assessing and paying for performance.
Financial metrics are important measures of a company’s ability to execute on existing products and services, but are generally lag indicators of performance and do not specifically measure and reward attainment of key strategic value drivers.
In considering whether to introduce non-financial metrics and what types of metrics to incorporate into an incentive program, the following are questions to discuss at your remuneration committee meeting:
- Have we identified key drivers of future growth and value creation and the associated elements of non-financial risk?
- Are we able to effectively measure how we are viewed by our customers?
- Do we need to raise awareness of critical key strategic imperatives?
Expect and Prepare for an Unexpected Impact to Your Remuneration Plans
These are turbulent times. From trade wars and tax law changes to major environmental events and the impact of global climate change, events external to businesses are buffeting financial results and impacting incentive remuneration outcomes. These new challenges to your pay-for-performance commitment make this a good time to review your adjustment policies.
Even in “normal” times, there are plenty of occasions to consider use of discretion to adjust incentive outcomes. These occasions may include acquisitions and divestitures; unusual swings in commodity prices, exchange rates, or interest rates; lawsuit settlements or regulatory actions; legacy asset write-downs; windfall gains and the like. Your remuneration committee should ensure it has thought through if, when, and how you might make modifications to the incentive plan before you begin an incentive cycle. Talk about the various scenarios by asking:
- What has been done in the past? Fairness for both management and shareholders begins with consistency and predictability. However, fairness also encompasses accountability for decisions made prior to the current financial year. For example, if there are significant customer remediations costs this year, track them back to the year that the mistake was made, and consider a corrected financial outcome on which that executive’s incentive that year was made. Re-calculate what it should have been and recover what was paid (usually with a malus forfeiture).
- Is the event unusual/extraordinary or is it the new normal? Truly one-time events might be treated differently, with greater emphasis on getting the right and fair outcome. But a new normal requires a greater focus on the impact such conditions will have on decision-making and the path to value creation. Insulating management from new economic realities they must manage can result in a chronic handicap to your business’ bottom line results.
- How might decision-making be influenced if adjustments are or are not made? The very purpose of incentive remuneration is to align the interests of management with shareholders. As referenced in the last point, you must understand the decision-making signal being sent by an adjustment (or lack of one).
- What is the magnitude of the event on incentives? Would an adjustment only result in a small, incremental change to the incentive outcome, or will it change a no-payout situation to a maximum payout (or something in between these cases)? Fairness and disclosure concerns may be different depending upon the magnitude of the adjustment.
Effective plan design—and executive remuneration governance—includes planning for the unexpected. Thoughtful preparation for the “known unknowns” and brainstorming “black swan” events can help the remuneration committee mitigate future risk, improve perceptions of fairness, and reinforce the commitment to pay-for-performance.
Never forget to explain ‘why’ you have or haven’t taken a course of action. If you can’t explain it satisfactorily is it the right course of action?© Guerdon Associates 2023 Back to all articles