This time each year we dust off our crystal ball to provide our outlook for director and executive remuneration. Through the lingering clouds of uncertainty, rays of sunlight illuminate great opportunities for businesses. Should boards want to seize these, executive pay will need to be tackled to facilitate, and not hinder, enhanced shareholder returns.
As we enter the third year of the COVID-19 pandemic it appears that companies and investors have learned to cope, such that most can readily adapt to contingencies that arise.
- Current supply bottlenecks will start to ease globally as COVID disruption (ex-China) abates.
- Australian inflation will be evident through much of the calendar year, but is not significantly structural as supply pressures ease.
- The Australian dollar FX rate will remain relatively low as other economies strain to rein in inflation with tightening money supply, benefiting exports.
- Australia will have robust demand for its commodities, a tight employment market, a highly vaccinated population with savings to spend, open borders reversing the net outflow of people, and higher employment participation – all fuelling the economy.
- Public, private and business spending will all be above trend.
- The Australian economy will strengthen: The IMF and OECD are both forecasting 2022 GDP growth of 4.1%, and most other forecasters are around the 4% level.
- Most industries should do better, other than manufacturing, although some of the growth in hospitality and travel industries will be from a low base.
The absence of a reform agenda from either of the major political parties going into the federal election suggests that productivity growth will continue to be anaemic not just in 2022, but successive years. Wage inflation is likely to creep past the pre-pandemic 2.5% growth average towards the end of 2022 and towards the underlying and elevated inflation rate.
Board fee increases
The FY21 median increase in ASX 300 chairmen NED fee was zero. However, for the 48.3% of the ASX 300 that provided an increase, it was over 6% (see HERE). While some of this reflects recovery of voluntary fee reductions during COVID, we would expect many of the other half to adjust fees in 2022.
Nevertheless, there is no indication that rates of NED increase will change significantly. That is, fee adjustments are likely to be between 5% and 6% for those boards that increase fees.
Executive fixed pay
2021 CEO fixed pay hardly increased from the prior year. The median increase in same incumbent CEO total fixed remuneration (TFR) was 0.9% over the 2021 financial year, whereas the Australian Bureau of Statistics Wage Price Index rose by 2.2% (see HERE).
Despite news media and others eagerly anticipating the “great resignation” evident in North America, and its subsequent levels of executive and general wage inflation, this is not yet evident in Australia. Overall, CEO fixed pay increases are likely to remain subdued with an overall median increase at between 1% and 2%.
However, there will be significant variation by industry and company, depending on changes in investor sentiment, business headwinds or tailwinds, COVID bumps, and scarcity of talent.
As most of the larger ASX-listed companies, despite their industry classifications have become, in their various ways, technology companies, the war for technology talent will continue unabated.
Professional services and certain functional jobs in risk management, cyber security, HR and (funnily enough) logistics have had a “supply” blockage from closed borders. As they are still trying to catch up, these will see above trend fixed pay increases.
2021 was a bumper year for incentive payments. To an extent, this was a make up for the first year of COVID as companies adapted and conserved but, overall, did much better than expected (see HERE).
Significant strategic constraints and opportunities will be encountered across industries as investors change focus, capital becomes more expensive and discount rates increase. In anticipation of higher capital costs, many will seek to make balance sheets more conservative. Reducing gearing will constrain growth and reduce returns on capital. This will be offset, to an extent, by robust consumption by both the public (until at least the 3rd quarter) and the private sector making up for the Omicron downturn from late 2021, taking up the slack in public expenditure towards the end of the year.
In a few companies the incentive opportunity may reduce, as companies amend pay frameworks (see below) to accommodate longer term transformation. Many will need assistance in how to navigate the change internally, and with investors and proxy advisers.
For many companies the relatively low Australian Dollar and high overseas inflation will see higher input costs, and reduced margins. These companies, if they have not already, will need to focus on maintaining margins, reflecting this in annual incentives.
As was the case in 2021, boards will need to consider if performance measures need amending, and at the very least, if performance targets should have more stretch. We expect most companies will need to review these in 2022-2023.
A brief paragraph on discretion is now common in larger ASX listed companies’ remuneration reports. We expect the trend to continue to trickle down the ASX.
Basically, investors want to know if the board formally considered whether to exercise discretion, what factors were considered, and any discretion applied.
Executive pay frameworks
Demands from large institutional investors to pay more heed to ESG factors are persistent and growing. Both State Street and Blackrock want companies to disclose plans for how they will adapt to a net zero economy.
As investors demand more focus on ESG issues or longer-term uncertainty, companies most exposed to climate risk will need to invest more transformation capital that will not see a pay-off within the usual LTI cycle. Sincere companies will need to accommodate this investment in executive pay frameworks, such as milestone incentives in place of, or in addition to, regular LTIs. Given the absence of support from one proxy adviser most companies will choose not to use LTI, although it is a trend worth monitoring.
Others may choose to use restricted shares which time-vest over a period longer than traditional LTIs. This has been observed in 2020 and 2021 in thoughtful, well-considered ways by several market leaders. While one proxy advisor and several investors will not like it, we expect this trend to continue.
The tightening of global money supply and higher interest rates will move investor sentiment from growth stocks to value stocks. This will have several implications for executive pay.
Some high growth industries such as technology and fintech will not be as highly valued as last year. Use of equity will lose currency. Some companies will feel forced to consider executive pay involving more cash, sooner, to stay in the hunt for talent. This will favour more mature cash generating technology companies.
More mature growth companies may see both investors and employees seeking more cash. Employees may see being rewarded with stock as less secure than cash, and they certainly would not want to see it deferred should inflation grow, notwithstanding that value companies’ equity remains a good inflation hedge.
Banks, insurers and superannuation funds still have a lot of work to prepare remuneration for compliance with APRA’s new CPS 511 regulation and the government’s FAR legislation (currently referred to a Senate Committee, such that it appears the Bill will not become effective until after the planned 1 July 2022 start date). The results of preparatory work already undertaken (or lack of in some cases) will become apparent with 2022 listed bank and insurer disclosures. Among these, we would expect restricted shares to feature to cope with longer vesting periods.
Global money tightening will see the rate of IPOs curtailed, and an M&A contraction from the high levels seen in 2021. But with global capital now nudging $400 trillion, and superannuation monies still pouring into Australian funds, we would expect a reasonable transaction volume.
The government is regulating proxy advisers, requiring their advice to be delivered to companies at the time it is delivered to their institutional investor customers. But of more consequence is the requirement for proxy advisers to be independent of security owners (see HERE).
In effect this means ACSI cannot provide proxy advice. Its superannuation fund members will probably receive Ownership Matters’ advice, albeit without ACSI’s overlay of recommendations. Practically, we do not expect this will result in major changes in proxy adviser emphasis in 2022, although activist resolutions may count on fewer proxy adviser supporters.
Industry funds and many for-profit superannuation funds will continue to seek out and consummate mergers to improve performance. They will enhance their in-house governance resources, making them more independent of proxy advice.
The proxy adviser changes may contribute to a more fragmented voting approach by industry superannuation funds. This is more of a trend acceleration than a change, given the ever-larger funds were building their own capability in any event.
The shorter-term impact for company directors will be a greater need to engage with individual funds, rather than just proxy advisers.
Longer term, there are fascinating developments companies need to plan for and act on sooner rather than later. Blackrock started the ball rolling by permitting some pension fund members to vote directly. It is Larry Fink’s response to “stakeholder capitalism” (see HERE). We expect this will be picked up by Australian industry funds as they wrestle a losing battle to be all things to their members. The likely bottom line is that companies will need to pay even more attention to ESG, including in relation to corporate purpose and incorporating it into executive pay.
Calendar 2022 will be a more “normal” year, as markets revert to the higher levels of volatility that were the norm before easy money.
That normative standard was pre-GFC, which excluded a proportion of the current generation of boards and management. While this generation has been surprisingly agile and adept at coping with staff absences, methods of customer engagement, and supply bottlenecks, new challenges will arise from increased capital costs impacting markets and strategy. At the least, this will require a re-consideration of performance measures and targets.
This being a federal election year also means openness to change must be driven by businesses and investors rather than politicians and regulation. To that end, ESG factors will underpin some of the change, and will also feature in executive incentive reviews.
In summary, executive pay frameworks and targets will need to consider margin and supply pressures, higher capital costs, changes in industry-specific investor sentiment, continuing talent shortages, increased regulation in some sectors, and more refined investor ESG expectations.
Good luck, and enjoy the ride.© Guerdon Associates 2022 Back to all articles