Paying for high inflation

US inflation has reached a 40-year high of 7.9%. Headline inflation in Australia is much lower (3.5% to 31 December) although it has exceeded the RBA’s 2-3% target range. Even so, every day more news articles are written about rising prices and the resulting decisions for business owners on whether to pass on higher costs. There is evidence arising from the most recent disclosures that US and UK same incumbent executive salary increases have been above the 2% rate for the first time in several years, but still below headline inflation.

Boards and executives are experiencing quandaries not encountered for decades, with some unions expecting 6% annual pay increases, and candidates in areas of scarce talent accepting offers one day, only to decline the next following a new, more lucrative offer.  The world has been in a low inflation status for so long, we suspect there are many “set and forget” decisions that have been made that will come back to bite companies. In remuneration, just as in many other disciplines.

Yet the amount of remuneration to pay is not the only decision to make. Remuneration structure and payment vehicles, performance measures, and time frame are considerations too.

In this article we consider remuneration structure and choice of payment type.

Following the first US interest rate rise, share prices have been volatile.  But theory says share prices will be negative or experience minimal growth as inflation continues to increase and the world reprices risk.

As described above, this may be due to pressure on earnings caused by increased input costs or reduction in demand for services, or reduced demand for equity given the increased return of bonds or lower “real returns” of equity after inflation.

An executive would have to be confident in their company’s prospects to highly value options at such a time.

At executive level there is a view that long term incentives will be worth less at the award/vesting than it would be at the start of the performance period.

If share prices go down (as might be the case) an employee may be looking at incentives that reduce in value over time, where cash would have at least retained value.

Value stocks will have held up reasonably well, as their stock will better retain (or gain value) and also pay dividends on the way.

Growth stocks on the other hand are suffering from volatile values. Should they restructure remuneration from the typical structure favoured by such companies – being low fixed remuneration, balanced by generous equity grants? Will employees still be tempted by this arrangement? This is already happening for those with sufficient cash flow to provide it. Technology and other growth sector companies must once again be agile and innovative with remuneration practices. (For an interesting discussion on value vs growth company remuneration, see the summary of the points made during our remuneration and governance forum (see HERE).

The proxy adviser and investor preference that will likely be challenged is the push for ever more remuneration to be paid long term. Long term incentives will be devalued even further than they currently are, as individuals will be discounting the amount by the percentage value it will lose each year until they get paid, no manner how that payment is made.

Those companies which are able to provide their employees money sooner rather than later, with hurdles (if any) the employee can control and in a format they value will win the talent war. The question is how to do this in the most effective manner without paying employees amounts that threaten profitability.

Directors should not doubt that the new normal will change many rules of thumb that have gone unquestioned for a long, long, time.

© Guerdon Associates 2022
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