Strikes, structures and strategies. These are the big three remuneration issues facing Boards and management in 2020, based on feedback in our national market survey The Remuneration Pulse and our recent client forum, Responsive Reward Trends and Opportunities in 2020 and beyond.
Now, in its second year, The Remuneration Pulse is part of our repository of proprietary research we regularly carry out covering a cross-section of Australian businesses and ASX company remuneration practices. The insights gleaned from our research were shared at the forum (see below if you’d like to take part in this working group) resulting in three central challenges framing anticipated themes in 2020:
- An AGM season without stress or ‘strike’
- A remuneration structure that balances risk and outcomes
- A broad-based reward program that engages and retains key talent
Reputation management – maximising shareholder support
For many Boards, the last AGM season did not pass without its challenges due to various reasons such as continued shareholder activism, increased governance scrutiny and expectation on performance alignment – as discussed below. Complicating matters, there was an upswing in ‘no’ votes on remuneration reports, with the number of ASX 300 companies receiving a strike or a near miss in 2019 increasing 14% on the previous year.
The main culprit for ‘strikes’ continues to be the misalignment of executive remuneration with company performance; typically, where a company awards an incentive payment to executives which is not indicative of the financial and/or share price performance over the year. The potential for company performance and executive reward misalignment was highlighted in our 2018 quantitative research across high and low performing ASX 300 companies. The findings provide valuable insights on practices adopted by high performing companies to strengthen performance and reward alignment including use of gateways, types of metrics and the period over which the metrics are measured.
While the past can help provide answers for the future, the 2019 Hayne report and changes in legislation are undoubtedly carving a new era for executive remuneration culture and risk practices (beyond just the banking sector) further stoking the ire of shareholders.
For listed companies, the revised ASX Corporate Governance Council (CGC) Principles (effective from 1 January 2020) include updates to Principle 8 which deal with fair and responsive remuneration. The changes, where adopted, aim to sustain best practice and compliant programs. Importantly, while the CGC Principles accept that remuneration is vital in being able to attract, retain and motivate high quality executives, it ends there. The amendments now reflect that remuneration to incentivise an organisation’s most senior executives should align with the growth and success of the organisation and not compensate behaviour that is divergent to the ‘entity’s values or risk appetite’.
Regardless if you’re a listed or private organisation, adopting remuneration best practices in response to changing legislation will set solid foundations for strong stakeholder support in 2020.
“While remuneration outcomes weighed heavily on the ‘strike’ report card, interestingly there were other emerging themes that may have influenced shareholder remuneration report voting.”
Our research also revealed a number of emerging themes that may cause concern for Boards in the future, and may well have an impact on shareholder voting on the remuneration report:
- Use of non-financial metrics for executive incentive programs. Conflict is emerging between legislators who want to increase the emphasis of non-financial measures versus shareholders and proxy advisors who expect executives’ reward to strongly align with financial metrics clearly linked to deriving shareholder value. Either way, it is likely companies will need to review incentive programs and enhance disclosure to ensure understandability and clear alignment with shareholder interests.
- Age and level of independence of the Board. Interestingly, the targeting of individual directors received more focus in the 2019 AGM season. While not specifically remuneration related, factors such as director independence, tenure and minimum shareholding, could potentially lead to protest votes on the remuneration report.
- Environmental, social and governance (ESG) factors that link to executive remuneration. ESG issues are particularly hot topics for shareholders, and the community at large. This was highlighted in the recent banking money laundering scandal putting a spotlight once again on governance failures (which arguably also influenced a significant ‘no vote’ on the remuneration report). Given the challenge of defining and measuring ESG type impacts on remuneration, companies will need to consider when and how discretion should be applied to ensure that Boards and executives are appropriately rewarded (or not). For instance, where an incentive outcome is not in line with expectations (considering ESG factors), Boards may need to apply adjustments to current and future earnings.
Remuneration Structure – the balancing act
Until Aristotle, most believed the Earth was flat. People saw the world from their perspective and created an answer that met their expectations. Executive remuneration practices can be somewhat similar.
When people read the ACSI report in September 2019 – which was critical of the fact that 99 of the ASX 100 CEOs received a short-term incentive (STI) payout in 2018 – many industry pundits came to the conclusion that executive pay is broken across the ASX.
Our research suggests otherwise.
Based on a sample of 100 small-to-medium ASX companies, representing all sectors (and who according to disclosed information, operate an STI scheme), we found only 51 CEOs received an STI payment in 2018. While there may be a mix of contributing factors behind the significant difference in an STI payout between the ASX-100 and our sample group, one likely reason is that compared to large ASX entities, smaller companies may have a relatively ‘simple’ view of performance and reward structures including the use of traditional incentive approaches and a limited number of performance measures. Interestingly, we also found a strong correlation between CEO’s STI payout and shareholder returns.
One challenge faced by companies in 2020 will be finding the right balance between non-financial performance metrics (e.g. culture) with appropriate remuneration outcomes.
Our analysis suggests ‘soft’ measures may have real benefits such as a positive TSR outcome almost twice as likely when executives are measured against non-financial metrics. However, too high a weighting on non-financial measures can potentially lead to skewed remuneration outcomes with STI payouts increasing from 49% to 75% when non-financial measures represent more than 50% of combined KPIs.
A good starting point for companies is to review the previous years’ remuneration outcomes against the key performance measures (financial and non-financial). Do the outcomes reflect overall company performance achievements? Are they in line with shareholder expectations? And, is there consistency with legislative expectations (CGC Principles)?
“Less than 50% of employers expect increases of 2-3% for workforce remuneration in 2020.”
Reward Strategy: best practices to guide remuneration and reward programs
As the workforce and labour market continue to evolve, it is increasingly essential for company reward and performance management programs to be flexible and broad-based for maximum utility. It is especially relevant in these times of benign wages growth.
Respondents in The Remuneration Pulse were restrained on their view of wages growth with less than 50% indicating an expectation for workforce remuneration increases of 2% to 3% in 2020.
To coin a phrase from a Lord of the Rings poem “All that is gold does not glitter”. Despite a cautious economic climate, there are many ways for companies to drive employee engagement and productivity that goes beyond the pay check:
- Implement a tailored benchmarking policy, specifically nuanced to direct finite funds into addressing challenges around key talent retention and acquisition.
- Design employee reward and benefit programs that align with the company purpose, enhancing employee engagement through the desire to work for a company with valued attributes.
- Create workforce recognition programs that deliver simple yet powerful rituals that habitually acknowledge other employee’s efforts. A simple ‘thank you’ goes a long way in the workplace!
- Increase the frequency and transparency of employee communications that keep the workforce informed and engaged.
Remuneration and reward trends in 2020 are pointing toward companies adopting a more holistic approach to maximise program value while balancing various stakeholder interests. Identifying best practices and adapting to suit will be critical for companies to ensure each reward dollar is best optimised.
The Reward Practice regularly releases insights and the latest thinking on remuneration trends and issues.