As calendar 2022 races to its end, we summarise the key remuneration trends likely to spill over into 2023.
Change often comes slowly in a field where multiple and conflicting stakeholder preferences, proxy voting guidelines and regulations all have sway. Often the safest route for a board is to navigate a well-trodden path and defer changes.
But changes are afoot. We describe executive and director remuneration developments of which directors should be aware, as they may increasingly become a feature of both company and shareholder deliberations in 2023 and beyond.
Longer vesting periods for long-term incentives (LTI)
Regulatory changes in the financial services sector are extending vesting periods for CEOs and other KMP executives. For example, this will now be up to 6 years for CEOs of the large banks, insurers and superannuation funds. Vesting horizons are considered in terms of alignment with the period over which risks can emerge within the business. This will vary across sectors, but more bluntly, if a wholesale shift has occurred in a key sector of the market, is a 3 year LTI vesting profile sustainable in businesses carrying long tail or emerging business risks? Outside of financial services, longer vesting periods are being implemented for most large companies. Investors may expect more of those exposed to climate change, social license or other existential threats.
There is no escaping non-financial measures’ increasing presence, profile and impact. The drivers of this trend have been:
- Regulation such as BEAR impacting banks; the perennially promised but deferred Financial Accountability Regime (aptly named FAR), impacting banks, insurers and others; APRA’s CPS 511 again impacting banks, insurers and superannuation funds;
- larger institutional investors with permanent long term exposure to companies they invest in;
- Industries threatened by regulatory limitations to their social license to operate, such as gaming and wagering, certain food manufacturers, resources companies, agribusinesses, energy utilities and suppliers, and monopolistic infrastructure providers;
- Customers; and
From initially small beginnings, this trend is global, and unrelenting. See, for example, Guerdon Associates’ GECN Group publication on the extent that non-financial measures feature in executive STI and LTI plans both globally, and in Australia HERE.
Removal of taxation on unvested equity when employment has ceased
If you missed it, the removal of tax for any unvested equity grant on termination has finally removed a thorn in the side of many an incentive plan designed for better governance. It has corrected what was an Australian competitive disadvantage in the global war for talent.
Equity grants no longer have to use “indeterminate rights” as a work around.
Boards and investors have long seen the impact of management’s decisions play out on company value after a CEO or other accountable executive has left the building, lamenting that the tax structure did not facilitate the retention of unvested equity post cessation. While CEO and KMP tenure can be around 3 to 5 years in a key role there is now no structural impediment to aligning their remuneration to a longer timeframe in which the real impact of their decisions and actions on business strategies/investment will play out – see HERE.
Long Term Equity (LTE)
Another back-to-the-future trend which has emerged from the companies needing to ensure long term executive alignment to shareholder interests in an uncertain world, or over time periods that defy traditional methods of setting performance targets. This has seen the grant of equity that is not subject to specific performance requirements, and that vests with time. A variation to meet regulatory requirements in financial services has seen some of these subject to a ‘pre-vest” test that performance was not, in effect, disastrous.
If any reader was around in the very large companies 4 decades or longer ago, you may sense some déjà vu. It was a good idea then, and remains so now, for certain companies.
The approach to date has been to trade-off a portion of volatile VR, for a lesser value as an annual grant of equity which vests subject to continued employment and not blowing up the business. Vesting of the LTE is long term (4+ years) providing alignment with shareholders and a mechanism to attract and retain talent. LTE can be useful for highly volatile environments where the setting of long-term performance hurdles is problematic, or those whereby performance today, tomorrow and next decade is an outcome from the legacies or prior generations of management– see HERE.
Holding periods for performance tested LTI
Holding periods for incentives that have been tested have emerged over several years as a way of bridging the gap between the period over which a performance hurdle can be reasonably set and measured (usually three years) and a longer vesting period of 4 years plus (see above re financial services sector) permitting a look back to confirm that results have been sustainable. There are positives in the use of holding periods in addition to shareholder alignment and supporting minimum shareholding mechanisms which overcome the common concurrent performance measurement, vesting and release process – see HERE and HERE.
You must exercise discretion, or at the very least, think about it…
Much to management’s chagrin, the market expects boards to consider and exercise discretion. In addition, it wants companies to communicate externally the circumstances and context that were considered. These are increasingly common in ASX100 disclosures. Equally important is where discretion was not exercised and potentially should have been (remember job-keeper payments anyone?). Boards may want to consider if incentive plan rules and equity grant offer conditions are up to date and provide for board discretion. Now may be a good time for some housekeeping. See HERE and HERE.
Deferral of vesting where ’issues’ arise – nuance around vesting consideration rather than all or nothing
This is a nuance which has emerged with the financial services sector regulation that is beginning to permeate elsewhere. Do your equity plans allow for the extension of vesting or holding periods where an issue has emerged or there is an ongoing investigation? Perhaps your plan rules are out of date.
Malus and clawback
Malus goes hand in hand with discretion. If incentive plans do not provide for malus adjustments (intra-period or prior to vesting) then a company will be out of step with market expectations. Clawback (repayment post vesting) is another issue but is mandated for those large financial institutions. It is also present in Australia’s large global multi-nationals. Law firms are increasingly aware of a need to incorpore provisions for clawback in new executive appointment contracts. Despite the legal challenges, clawback provisions are making their way through ASX listed companies.© Guerdon Associates 2023 Back to all articles