With the beginning of a new financial year for most ASX listed companies we dust off our crystal ball to provide our new FY outlook for director and executive remuneration.

Within the business community what many have anticipated for 2 years has arrived. High interest rates are crimping both consumer and investment spend and increasing funding costs. Inflation has lifted payroll and supply expenses. With demand down, growth is anaemic. Profligate government spending to “ease cost of living” will mean high interest rates for longer. There is a higher probability of recession.

For those with long enough memories, we have been here before. This has what we think are obvious implications for executive pay and board fees.

Board fee increases

The FY23 median increase in remuneration was 2.2% for chairs and 3.3% for other NEDs (see HERE).

We have seen some advisers projecting NED fees to increase at the same rate as average weekly earnings. The last Australian Bureau of Statistics release in November 2023 showed this to be 4.5%. The Reserve Bank forecasts this to be barrelling along at 4.1% to the FY24 FYE, and still running at 3.8% for FY25 (see HERE).

Over the decades, we have rarely seen NED fees increase in line with general employee weekly earnings. The dynamics are different. Boards consider the outlook and investor sentiment, and are more forward looking. Employee earnings reflect labour supply and demand and inflation, and are backward looking.

So despite high inflation and employee wage growth, we expect to see FY25 NED fee growth to differ from general workforce earnings growth, with median increases at approximately 2.5%. Chair fee increases will be lower.

Executive fixed pay

Last year CEO fixed pay increased 3.1% (see HERE).

On a same incumbent basis, approximately half of all ASX 50 CEOs are receiving no increases. For those who do, the median increase is just under 4%. Across the whole sample, this leads to a median increase of 2% or less. During tougher times, we generally see higher CEO and executive turnover. As most are replaced from within, all incumbent executive pay levels may not move much at all.

The interquartile range (25^th percentile to 75^th percentile) of increases will be wider than in most years, as companies respond to high inflation and the impact on business operations differently.

There will be significant variation by industry, job family and company, depending on changes in investor sentiment, business headwinds or tailwinds, and labour supply. Most industries, including mining, technology, consumer discretionary, telecommunications, property, consulting and other services will be subdued. Pockets in the energy sector will be buoyant, given trillion dollar spends on generation, networks, and other infrastructure. Construction has experienced a rough run, but should improve to the end of 2025.

Board remuneration committees need to be very discerning. They may receive purported independently sourced or advised information based on “peer” company pay movements that suggest a generous increase is warranted. Be sceptical, and look closely at these peers. Do not accept a multi-industry peer group based on market value that is not reflective of your industry, or peer companies not competing directly for your talent.

Executive incentives

While we do not expect a shift in the balance of short term and long term incentives we will continue to see a change in emphasis on the measures they are based upon.

Within STIs, we are witnessing a shift in the balance of performance measures away from non-financial measures to financial measures. This reflects growing concerns with rates of capital return and reduced yield compared to bond yields. Keep in mind that, despite some exemplars of share price appreciation in mining and technology, most TSR since the GFC has been delivered via dividends. Now this is in danger of shrinking as boards have reprioritised, focussing management on balance sheets and PBT margins. While most of our clients have healthy balance sheets, all are noticing higher costs of capital. Some boards are wrestling with the need to raise new equity capital while share prices are high, pay down debt, reduce interest costs and prepare for a higher WACC and a rougher ride. This in turn suggests boards need to consider what capital raisings do for return on capital and EPS targets so executives do the right thing for company sustainability.

A few companies will see counter cyclical opportunities, as will private equity and large super funds seeking to privatise sustainable cash flows. These would do well to ensure incentive frameworks (especially LTIs) are configured to recognise longer term value derived from successful acquisition strategies.

Targets for many companies will reduce from prior. This will irk investors, who may react as they did last year when Australia recorded a record number of high remuneration against votes (see HERE and HERE). Boards need to take courage, and the heat, to maintain executive focus on achievable outcomes that would still arrive at an optimal outcome for investors given the conditions. Just make sure targets are consistent with guidance or analyst consensus forecasts.

The focus on financial results does not mean ESG measures and targets go out the window. They are here to stay. But boards will need to be more discerning and focus on those non-financial measures that can turn the dial on risk and return. A focus for some investors will be the published WGEA gender pay gaps, although few boards have adequately considered gender pay gaps in their incentive frameworks.

The legislated Safeguard Mechanism also requires the largest 215 emitters to significantly reduce carbon emissions. It is critical for those that are publicly listed companies to find incentive frameworks that facilitate this, with some long term incentives already in evidence, and likely to show further refinement in FY25.

APRA-regulated entities have for the most part shifted part of their performance incentives to service-based restricted share grants. These are already ubiquitous for non-KMP level employees in larger companies across all industries. It makes sense for these frameworks to gravitate upwards to KMP executive level, accompanied by higher mandatory shareholding requirements to ensure “skin in the game”. While not a high growth trend, expect to see more companies adopting these pay elements for their executives, especially those with global operations and exposure.

Investors

As noted above, last year investors flexed their muscle. There were record remuneration “strikes” or near strikes on executive pay. Most, but not all, of the “sinners” will seek approval this year by responding to concerns. But with negative earnings growth, lower dividends and lower TSR, some companies may expect to be in the sin bin again this year and suffer high against votes. This need not be so, providing remuneration is not only reasonable, but engagement is effective. Boards in this dilemma would do well to seek advice, and soon.

Despite this warning, we do not expect a high number of adverse votes at FY24 AGMs on remuneration reports or CEO equity grants. It will be a sober, balanced and reflective voting season.

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. Therefore for listed companies, especially those in the ASX 100, incentive frameworks will need to emphasise cash flow, and support capital strategies that reduce risk.

Concluding remarks

Boards with sufficient diversity to include directors who remember the early 1990s can take heart from their war stories. It is not half bad, really. There is still money sloshing around, resilient employment levels, and a chance that recession will be avoided. The trick is to have executives focus on the short term things to deliver cash earnings and maintain profit margins, but not forsake opportunities for growth and positioning at the end of this cycle, even if the fruits will be for successors to inherit.

In summary, executive pay frameworks and targets will need to play to investors with a more short term focus, which means careful consideration of free cash flow, lower growth and investment, margin and supply pressures and higher capital costs. The trick will be not losing sight of the longer term emissions reduction and strategic growth initiatives that will set companies up for the next upswing.

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