As we approach the end of the financial year, companies will begin to determine 2021 incentive outcomes and contemplate what form they may take for next year. With ongoing uncertainty par for the course, this year presents a persistent set of challenges across sectors, particularly when considering improved performance for many companies and the anticipation of greater amounts of STI (Short Term Incentive) being paid.
Will STI payouts be greater than last year?
Despite volatile financial outcomes due to the pandemic (noting there are variations based on sector), Fig 1. below shows our preliminary analysis of company expectations suggesting a rebound in STI payouts for CEOs (potentially even above pre-Covid levels).
Fig 1. Executive remuneration – CEO STI payout
The responses to date showing STI payout expectations are somewhat surprising taking into account the overall financial effects of the pandemic on Total Shareholder Return (TSR) coupled with the level of shareholder scrutiny on executive bonus payouts.
This potential misalignment between CEO STI outcomes and shareholder returns may pose a challenge for Boards this year. But then again, it may not!
Do STI payouts drive shareholder voting outcomes?
We explored the relationship between STI outcomes and TSR to understand the level of alignment and the subsequent voting on remuneration reports.
Fig 2. below shows the relationship between CEO STI outcomes and company TSR for a sample of metals and mining companies in 2020.
Interestingly the company TSR performance and corresponding STI payouts for CEOs provide a wide range of outcomes including:
- Good alignment of pay for performance – executive STI outcome and shareholder returns are correlated. For example Fortescue Metals Group.
- Potential misalignment of pay for performance – executive STI outcome and shareholder returns are not correlated. For example Syrah Resources.
The analysis above is arguably limited with TSR as a single indicator of company performance and not typically measured for STI purposes. Shareholders are likely to consider appropriateness of STIs from a number of perspectives such as other remuneration elements, levels of disclosure and broader performance measures to name a few. However, TSR is unquestionably an important consideration for investors in the context of understanding the appropriateness of outcomes for executive pay.
What should companies be doing now?
As we approach the end of the financial year, what can be done if it looks like your executives’ bonus payouts may not align with shareholder returns?
1. Build your evidence base for an informed view
To understand the appropriateness of an STI outcome, the following insights should be considered:
- Business performance – to what extent does the STI reflect the achievement of company value drivers? How does the outcome change under different scenarios?
- Individual performance – how has the individual contributed to the business performance?
- Shareholder views – is the potential outcome aligned with shareholder / proxy advisors?
- Market relativity – how does the outcome compare with relevant peers?
Our mid-year Remuneration Pulse provides insights on expected STI outcomes along with other remuneration trends. Please click here to take our 3 minute, 4 question Pulse Survey and the resulting Remuneration Pulse Report will be delivered to your nominated inbox in early May 2021.
2. Review the STI program for next year
The current climate has resulted in a rethink of incentives, adjusting to a different working world. In anticipation of having changes in place and communicated next year boards may wish to consider whether the current incentive plan reflects:
- New strategies and performance horizons driving business imperatives in the next 12-18 months (e.g., cost out projects, pursuit of new markets, innovation)
- Metrics and/or gateways that focus participants to achieve business imperatives and result in appropriate payouts
- Governance mechanisms including discretion which the Board can apply to ensure appropriate outcomes in the best interest of the company, the individual and shareholders. (Read Exercising Discretion When The Unexpected Occurs)
3. Stakeholder engagement is key
To the extent there may be levels of misalignment with shareholders (i.e., not passing the ‘pub test’) Boards should proactively communicate the commercial rationale for the incentive outcomes and why they are in shareholders’ interests.
Effective engagement can be managed through the remuneration report and directly with shareholders/proxy advisors. In both cases, clearly conveying what STI outcomes have resulted, how they were determined and importantly explaining why.