This time each year we dust off our crystal ball to provide our outlook for director and executive remuneration.
Last calendar year, companies had to rapidly adapt to changes in the economic cycle. Most listed entities handled this well, although it was brutal for technology and other companies without positive cash flow. For the most part, companies now know where they stand with investors and their respective markets.
For those with long enough memories, we have been here before. When cash is tight and expensive, investors appreciate when you give some back, and deliver ahead of schedule. This has what, we think, are obvious implications for executive pay.
We are getting used to the idea of a tightening economy, in which cash is expensive and likely to get more so before calendar 2023 is out. But some other economic considerations are still to work their way through the system.
- Supply bottlenecks have seen economies retreat from global supply chains to regional ones. To an extent, Australia and New Zealand’s “tyranny of distance” used long established logistics buffers to counter some of the breakdowns in global supplies. Yet, the absence of local and regional economies of scale in manufacturing will see continued reliance on global supply chains more so than in more densely populated regions.
- The supply issues have abetted high price inflation as ASX and NZX companies apply the first rule of economics 101 – when demand exceeds supply, put up prices. Revenue and margin maintenance from this strategy will be constrained in the latter half of 2023 as consumer demand drops off due to cost of living pressures.
- Consequently, many sectors will seek to retain margins through cost reduction, including employee layoffs and reduced hours. Tighter money supply has already seen this in some sectors, such as technology. Real estate and construction will follow.
- Earnings inflation will remain high. It will not abate with a return to high immigration to combat skill shortages, given unemployment will remain low, and more centralised bargaining will push up wages in union monopolised industries.
- Australia will continue to have robust demand for its commodities. Established minerals and fossil fuel commodities will experience solid demand from China and its neighbours. Newer in-demand commodities will continue to attract growth capital, although its cost will demand rapid development of facilities to generate cash sooner. This will maintain skill shortages in mining, offset by government intervention in energy markets that will assist to constrain application of growth capex.
- Other than in mineral commodities, most business spending will all be below trend.
- The Australian economy will weaken: expect GDP growth to be 1.6%, below 2022’s 3.7%. While unemployment will remain low, the rundown in real earnings and savings from high cost of living increases, and reduced wealth impacts from asset deflation will reduce consumption.
- Most industries, excluding resources, will do worse, although some growth will be evident in hospitality and travel industries from a low 2022 base.
Most governments are supporting solid increases in aged, health and disability care sectors. Low unemployment and employees under cost-of-living pressures will fuel around 3.8% wage inflation during 2023.
Board fee increases
The FY22 median increase in ASX 300 chairmen NED fee was 3.8%. However, for the 75% of the ASX 300 that provided an increase, it was over 6.4% (see HERE). We would expect many of the others to adjust fees in 2023, as NED fees generally follow CEO fixed pay adjustments.
Given the likely slowdown in the economy we expect the rate of increase to reverse. That is, fee adjustments are likely to be 4% or less for those boards that increase fees.
Executive fixed pay
In 2022 CEO fixed pay increased, but for the first time in a decade exceeded general employee earnings increases. The median increase in same incumbent CEO total fixed remuneration (TFR) was 4.5% over the 2022 financial year, whereas the Australian Bureau of Statistics Wage Price Index rose by 3.1% (see HERE).
Overall, CEO and other executive fixed pay increases are likely to be lower than prior to be under 4%. They will revert back to lagging general employee increases, and reflect a tightening economy.
However, there will be significant variation by industry, job family and company, depending on changes in investor sentiment, business headwinds or tailwinds, and labour supply.
2022 remained a good year for realised incentive payments reflecting the post Covid bounce and sustained demand.
2023 will be more mixed, and less than in 2022 as some industries will experience a slowdown as the economy tightens.
2023 measures will still retain a strong financial results focus. These will be harder to achieve given economic headwinds. The measures will tend to be on underlying earnings or cash flows, and reducing debt. Earnings growth targets will be less than prior.
Despite the heightened need to generate and distribute cash to shore up TSR, the emphasis on ESG measures is not abating. Expect to see little change in the annual incentive framework weightings.
There will be more change in LTI measures and weightings. APRA-regulated entities are still refining non-financial measures mandated by regulation, and placing this in LTIs, or inserting them as “underpins” in otherwise service-based restricted share grants.
Outside of financial services, many other companies are introducing non-financial measures in LTIs. This is necessary given that the myopic emphases by many investors do not appropriately price the costs of carbon and other costs requiring capex. In response, external stakeholders keep lifting the bar, expecting harder and more measurable targets, especially on climate related measures.
Executive pay frameworks
More APRA-regulated entities will introduce time-vested restricted stock plans, with pre-vest “underpins” requiring a minimum performance standard before vesting.
Other industries will see more companies introduce ESG measures into their LTIs.
Industry funds and many for-profit superannuation funds have merged, and enhanced their in-house governance resources, making them more independent of proxy advice.
Proxy advisors and investors will demand more and stretching quantitative ESG targets. This will be important for companies with ISS-influenced investors. CGI Glass Lewis and ACSI funds will want to see a more direct connection between sustainability reporting and incentive measures.
Given the rising cost of money, most investors want to see more of it, now. They do not want to see it deferred, and discounted to nothing. For listed companies, especially those in the ASX 100, incentive frameworks will need to emphasise cash flow, and support capital strategies that see high levels of distributions to shareholders.
Calendar 2023 will see markets settle into managing for higher levels of volatility that were the norm before easy money. As the “norm” was decades ago, this will still require some adjustment to incentive arrangements. At the least, this will require re-consideration of performance measures, weightings and acceptable performance ranges.
In summary, executive pay frameworks and targets will need to consider free cash flow, lower growth and investment, margin and supply pressures, higher capital costs, changes in industry-specific investor sentiment, continuing talent shortages, and more refined and higher investor ESG expectations.© Guerdon Associates 2023 Back to all articles