The temptation for most remuneration committees is to revert to tried and tested, boilerplate remuneration solutions. And, in fact, this may well be the appropriate approach for many listed companies.
But the best of these committees are seeking to transform themselves from a relatively low-key and reactive role to one of initiating and managing changes in policies and systems to support the business and anticipate its challenges and future needs.
What follows is a checklist for the general characteristics that seem to be shared by the leading committees we have observed over the past few years. We do not expect these to change with the two strikes law:
- Be proactive: Recognise and address the growing burden of regulatory requirements, but maintain an appropriate focus on the direction and needs of the business and developing the supporting remuneration strategy. Manage potentially contentious issues to avoid unnecessary controversy and recognise the need to provide investors and proxy firms with an understanding of the rationale for various policy initiatives. Communication is pre-emptive, rather than reactive.
- Be prepared to deviate from the accepted norm: This may be a big ask in the 1st year of the two strikes law. But while adopting policies that reflect “standard market practice” may be non-controversial, effective committees understand that ‘best practice’ may not be appropriate to the company’s circumstances and culture, and may compromise an opportunity for it to gain competitive advantage. However, as previously mentioned, also understand the need to clearly explain the rationale for decisions that challenge the prevailing wisdom.
- But acknowledge and incorporate risk management. Too few companies outside of financial services adequately address their responsibilities under ASX Governance Principle 7 to recognise and manage risk. Remuneration is an operational factor that could be used to assist the board with this responsibility. It could be by ensuring executives’ bonuses are part deferred with a “hold back” for after-the-fact discoveries of unsustainability or riskiness, extra vesting time tacked on to a LTI performance period, or ensuring LTI remains “live” post employment to ensure better succession planning, or performance measures include a measure for risk (e.g. in the cost of capital), or any number of a host of other actions that could be considered.
- Actively engage with external stakeholders. While institutional investors and proxy firms do not want you turning up on their doorstep every year to say that the things they were happy with last year have not changed, they are interested to understand how and why you want to change things. Plan this carefully, execute it well, do not waste your time and theirs, but make sure all are happy with the change before it gets to a formal vote.
- Differentiate pay with performance: Good committees challenge “one size fits all” approaches and ensure that key executives and high potential individuals are being appropriately rewarded, developed and subject to arrangements that reinforce the prospects for their retention in the business. Although it is appropriate to consider both internal and external candidates, studies have shown that the availability of well-prepared internal candidates can reduce risk and possibly improve performance, as well as being more cost-effective, as reported in previous newsletters.
- Ensure legitimate pay for performance structures are in place: Committees need to be aware of the company’s performance relative to others in the industry, based on profits and returns, and to be focussed on the key performance drivers that will deliver maximum value to shareholders. Reviewing analysts’ projections and identifying emerging deficiencies in relative performance will in part achieve this. The analysis needs to include an assessment of the causes of inferior performance, particularly whether it is the result of management decisions or is affected by external factors outside the control of management. Importantly, rewards must be linked to performance in areas that are within management influence and control and commensurate with the quality of that performance.
- Avoid confrontations with management, without compromising decisions: Do this by establishing and communicating a sound remuneration philosophy and guidelines that provide clarity about the situations in which exceptions will be made.
- Seek to improve committee performance and effectiveness: Evaluation of committee performance, review of the quality of support received from external consultants, review of new trends and developments in remuneration, monitoring changes in shareholder and investor group attitudes and assessing new and proposed regulatory developments can all help to ensure optimal effectiveness of the committee. A structured induction process for new committee members allows them to rapidly gain knowledge of the issues driving remuneration policy and practices and enables them to quickly become effective contributors to the decision-making process.
- Keep the full Board informed: Remuneration issues, particularly those relating to executives, are often controversial. Even prior to the two strikes law, all directors needed to have an understanding of the rationale for remuneration recommendations and decisions, requiring the committee chairman to communicate regularly with all board members to provide background and obtain their input. This, however, must be achieved without the committee abdicating its responsibility for oversight of remuneration issues on behalf of the full board.