The AGM season invariably generates criticism from shareholders, the media and the wider community regarding allegedly excessive levels of executive remuneration. Comparisons are regularly made with the ‘modest’ salaries of ordinary workers.
Remuneration committee chairmen and their committee members search for ways to respond to these criticisms. However, they do not want to compromise their obligation to ensure the sustainability and enhancement of shareholder value through the application of remuneration policies and practices that successfully attract and retain leadership talent in a competitive market. Sound remuneration practices should be defensible through clear and detailed communication.
Guerdon Associates provides the following guidelines to help remuneration committees assess the quality of their remuneration programs and avoid criticism of their remuneration practices.
1. Don’t clutter executive pay with special privileges
Try to minimise the use of special benefits that are not available to the general employee population within the company, and which probably have little, if any, impact on executive attraction or retention.
2. Carefully select performance measures
Make the major part of executive pay dependent on the achievement of results and ensure that the performance measures applied reflect the company’s specific circumstances and business objectives. Don’t slavishly follow ‘accepted’ market practice if universally favoured measures are not appropriate for your company.
3. Calibrate performance requirements for reasonableness
Several times in the past two years companies have been criticised not so much for the performance measures they use, but more for the actual requirements for executive payments. For example, if selecting an EPS growth requirement, insist on your adviser estimating both probabilities (based on past company and competitor performance) and expectations (based on the implicit market expectations of earnings growth built into the current share price). Calibrate the threshold from these minimum requirements, and build the reward upwards should these be exceeded. There have not been any issues to date with shareholder approval of remuneration that was reasonably and comparatively generous where performance exceeded expectations. Explain these in your remuneration report.
4. If using relative measures of performance, select a relevant comparator group
Bigger is not necessarily better. A large group of companies or an index that does not have sector or business relevance will deny executives the ability to control their reward outcome. It will therefore not be motivational and could be detrimental to both attraction and retention. This is a continuing challenge in the small Australian market. Finding companies with similar businesses might mean accepting a limited number of comparators having vastly different size. However, there are mechanisms that can be used to modify ‘raw’ measures – such as capital weighting or risk adjusting TSR.
5. Analyse the nature of peer companies selected for benchmarking remuneration levels
Remove companies with extreme remuneration levels from the peer group. Assess the remuneration levels of peer companies by reference to their performance, size and complexity (including the geographic scope of their operations). Remember that the market data represents a guide to remuneration levels, not a recommendation. Remuneration committee members need to exercise discretion from their position of independence and drawing on their experience and understanding of the company’s specific circumstances, both current and emerging.
6. Be alert to the possibility of excessive pay outcomes
Review the relativity of CEO pay to other senior executives and question whether there is appropriate pay equity between the positions. Check that executive service agreements provide fair and reasonable compensation outcomes following events such as change of control, rather than windfall gains that do not reflect alignment of outcomes with shareholders’ interests.
7. Ensure that failure is not rewarded
Avoid commitments to pay multi-year compensation in the event of severance resulting from poor performance. Shareholders rarely find fault with the remuneration practices of companies delivering strong financial performance. Make sure that reward is structured to provide outcomes commensurate with the organisation’s results.
8. Dare to be different if it’s right for your shareholders
2007 has seen a much greater variety in executive pay platforms as boards seek to use remuneration to build on their company’s competitive advantages. Shareholders and proxy advisers have been more accepting of difference. A company planning major transformation would not be well served by a traditional STI/LTI remuneration structure for their executive, or necessarily cash and shares for non-executive directors. A private equity model may be more appropriate. If the executive team already has significant ownership of the company, consider structures without LTIs. And there are many more variations that depart from traditional models that may be better suited to your company’s situation. Consider these, test them with executives, shareholders and proxy advisors and, if appropriate, move to have them implemented.
9. Be prepared to defend well-considered remuneration decisions
Anticipate questions and concerns from shareholders and the wider market. Be on the front foot in stating the company’s position and remuneration rationale. This means planning and preparing the communication strategy, which should include briefing institutions and investor groups. Increasingly we will witness the emergence of remuneration practices that reflect the needs, business strategy and circumstances of the business. This implies deeper consideration of what is appropriate for individual companies, rather than looking sideways at general market standards. A process of analysis and considered response to business needs will result in the emergence of a clear rationale for remuneration policy and make the communication task easier for those charged with explaining it to the market. Doing so will add value for your shareholders.