Managing Executive Remuneration

Managing the level and structure of executive remuneration is a key responsibility of the Board and particularly its independent directors.  Increased focus since the GFC has led to more stringent disclosure requirements along with greater consequences for Boards that are not in tune with their shareholders.  In short, Boards are more accountable than ever for the effective management of executive remuneration.  At Mastertek our consultants are experts in the field with a track record of assisting clients with the key challenges including;

  • Clearly demonstrating how remuneration drives performance & aligns with tangible business outcomes.
  • Continuing to engage, motivate & reward executives with the appropriate capabilities to deliver shareholder value.
  • Ensuring absolute compliance with legislated disclosure requirements, processes and regulator mandates

Start With Your Principles

All good design needs strong foundations and Executive Remuneration is no different.  Various inputs need to be drawn upon in order to establish an effective set of ‘guiding principles’ or philosophies.  The ASX Corporate Governance Council’s Best Practice Principles offer the best place to start – particularly as there is an ‘if not, why not’ requirement when it comes to mandatory disclosure requirements included in your Remuneration Report.

Amongst the principles and associated recommendations and guidelines, a first key reference is regarding the role of your Remuneration Committee and the guidance as to how companies should design remuneration.  Immediately we see the first references here to the recurring themes of performance and long term success.  The latter can often be the hardest to get right and is often the root of negative feedback when shareholders vote on the Remuneration Report.

The ASX recommendations go further to drill down into the “components that should be considered in formulating packages”.  A summary of the four components are shown below– and again we see numerous references to performance – perhaps they’re serious!…

For a greater insight to the best practice principles click below for further reading.


Best Practice Design Principles for Executive Remuneration
Fixed Remuneration

Fixed Remuneration

  • Reasonable and fair
  • Taking into account the company’s legal and industrial obligations
  • Labour market conditions
  • Relative to the scale of business
  • Reflect core performance requirements & expectations.

Performance-Pay

Performance-Pay

  • Linked to clearly specified performance targe
  • Designed around appropriate performance benchmarks that measure Relative performance
  • Provide rewards for materially improved company performance.

Equity-based Remuneration

Equity-based Remuneration

  • Linked to performance objectives or hurdles
  • Should clearly prohibit arrangements which limit the economic risk of participating (no hedging)
  • Exercise of any entitlements timed to coincide with trading windows

Termination Payments

Termination Payments

  • Termination payments for CEOs should be agreed in advance
  • They should include detailed provisions in case of early termination
  • No payment for removal for misconduct.
  • Clearly articulate performance expectations.

Beyond the ASX guidance, at Mastertek we believe the principles of Strategic Alignment can support the broader principles very effectively when executed well.  Philosophically, reward and remuneration programs should not be set up in isolation but designed to support the behaviours and contributions that will lead to organisational success – creating our link back to performance.  In summary, the concept of strategic alignment when applied to executive remuneration design suggests:

  • The reward strategy and its various components should be considered as a continuum from individually focused elements through to group-based reward levers.
  • Similarly, the continuum accepts that some aspects (e.g. fixed pay) are essentially costs of doing business – the cost of getting people to come and work for us
  • We also recognise though that many aspects of reward should be flexible according to results – again, ensuring the relationship with performance

In order to ensure alignment with business strategies and objectives, we obviously need to ensure we have a clear understanding of what success looks like.  This understanding begins to lay the foundations for our reward programs and is where we ask ourselves:

  • How do the current capabilities stack  up
  • How big is the talent pool we can draw from, what is the availability of key talent

Answering these questions starts to inform the potential market positioning we will need to target in order to attract and retain the people we need to create success.  We’ll also start to form opinions around what kind of leverage we will need to create in order to drive performance.  From here then we can start to think about our reward plan designs.

Factors That Shape Design

Beyond the more generic design principles, there a numerous ‘situation specific’ considerations that will help to shape best-fit – rather than best practice – reward solutions for your Executives.

Our model shows the range of inputs and considerations we might need to work through in order to determine what is appropriate.

We’ve mentioned Strategic Alignment already and the idea of understanding required capabilities and availability of those skills in the market.

We also need to be conscious of stakeholder perspectives – shareholders (we’ll come back to), employees themselves (of course) but also customers.

A great question to ask yourselves when designing rem plans is ‘what would our customers say if we told them how we intend to reward our people’.

Design Factors

Shareholder Engagement

Advisory groups and institutional shareholders all have their own principles and voting checklists that they promote to their clients as a guide to what remuneration should look like – particularly in the case of Long Term Incentive plan design.

Our advice to clients is that you should wherever possible engage early and directly and develop strong relationships.  The ASX guidance supports this approach.

For example, they suggest that whilst you are not generally required to obtain shareholder approval for equity-based incentive plans for senior executives who are not directors it may be useful to test proposed equity-based incentive plans with shareholders in a bid to provide the board with a timely assurance that a plan is seen as reasonable.  Check out our High-Gain Questions for Shareholders for some tips on how best to start a conversation about executive remuneration practices.

Paying The Person

It’s worth reminding ourselves that remuneration is essentially a person-based decision.  Candidate-specific considerations should fundamentally be based on the skills, experience and contribution that the individual brings to the organisation.  When coupled with the organisational context we can really begin to refine the approaches that we need to employ.

For example – how critical is the individual’s skill set to our future success?  This might inform how hard we need to work to ensure they don’t leave – which in turn starts to suggest longer-term, retention based levers need to be pulled.  Alternatively, we may have a critical downsizing program to drive through and should then be focussing on shorter-term incentives aligned to the key milestones that need to be achieved.

  • Flight risk and impact should be considered
  • The effectiveness of succession planning frameworks might assist
  • Consider the future potential to deliver strategic objectives as well as past performance
  • Ensure that behaviour and style are factored in

Essentially, the aim is to map the needs of the organisation to the capabilities and potential of the individual.  This leads us on to thinking about an appropriate pay mix

Get The Mix Right

When thinking about the appropriate make-up of executive remuneration packages, the pay mix and plan design should be tuned to the nature of the role in question as well as the organisational context more broadly.

For example, the ASX principles suggest that Directors should be remunerated quite differently from Executives.  Why?  Because they are tasked with a different set of responsibilities.  Or as another example – consider Doctors versus Sales Executives – quite different approaches to reward you’d hope!  In Finance, as another example, regulators are having more and more of a say and this is shaping trends in reward design.

Setting The Right Levels

Effective and appropriate benchmarking can provide a quantitative input for decision making and also offers a rearview mirror – how well did we meet our targeted outcomes?

However, benchmarking is never conclusive in its own right.  It doesn’t tell us whether arrangements are appropriate or not (though it may help understand potential effectiveness) as we need to consider those situation-specific factors mentioned above.

Essentially, we need to contextualise the numbers in order to decide where we need to pitch remuneration and, when looking at past outcomes, whttp://www.mastertek.com.auhether our programs have been effective.  Traditional approaches have tended to focus on the relative positioning of remuneration, but ignore the performance aspect.

Given one of our principles is to reward performance we need to adopt a different approach such as referencing our Performance Pay Index which offers some great insights into the correlation between pay mix and company performance.

The Performance Pay Index

In the chart above we are looking at a map of the Performance Pay Index results for CEO’s across the Top 500 ASX listed companies – we’ve highlighted the financial sector for example purposes (the green dots) and a specific CEO’s positioning in red.

In our standard index (where we use 3-year weighted ROE as the performance proxy) the median PPI score for CEO’s across the whole group is around 100 – i.e. a direct correlation between relative remuneration and relative performance levels.  Of course, this doesn’t consider absolute amounts paid to different CEOs (but that is a different benchmarking exercise).

You can see from these examples how we are able to take a more contemporary approach to benchmarking executive remuneration – an approach that more fully aligns with the sorts of principles your organisations will have adopted to underpin your reward strategy.  This kind of information can really help you understand how effectively the reward programs are aligning with performance outcomes.

Tell and Sell Your Story Effectively

We believe that the mandatory Remuneration Report be treated as an opportunity to gain a competitive advantage by effectively communicating your organisation’s reward strategy.  Our advice is again consistent with the ASX guidance as compliance with listing rules requires an explanation of the extent to which you have followed the Corporate Governance Council’s Recommendations (or provided reasons for adopting alternative practices).

One of our favourite tests is to ask yourself ‘Will the RemCo chair be able to answer any difficult questions at the AGM?’.  Our job in designing the reward programs is to make sure they will have all the answers, and that those answers are credible.  This requires a clear philosophy, articulated through guiding principles.  We then need to design our plans in accordance with these principles and with the situation-specific questions answered.  Only then can we communicate openly and effectively.

Below we’ve suggested some ‘Golden Rules’ that can help your organisation capitalise on its Remuneration Report approach.   The rules are aligned and in tune with legislative guidance from both the ASX Corporate Governance Council and ASIC to give you confidence that the outcomes will be compliant as well as adding value to your stakeholder engagement strategy more generally.

Check out our Guide to Effective Remuneration Reporting which includes some great examples of best practice.


read on
Use Plain English

Use Plain English

  • The Rem Report should be considered as a communication tool first and foremost and should therefore use plain English and convey messages in clearly
  • Avoid the use of technical language, unknown acronyms &/or sophisticated legal jargon which may confuse stakeholders, or worse, make them suspicious
  • Complex statistics (e.g., around the mechanics of an LTI payout) should always be accompanied by layman explanatory comments, charts and images to facilitate understanding

 Example: In the past we have seen tables which simply state ‘-’ in certain cells.  If this is intended to mean “not applicable” then for the sake of avoiding confusion, state that!

Establish Alignment

Establish Alignment

  • Build a remuneration strategy for Executives that supports corporate objectives
  • Make this link clear for stakeholders to see

Tips…

  • Make this link early on in your report to reassure stakeholders from the ‘get go’.
  • Document the key principles of your rem strategy, e.g., shareholder return, market competitiveness or pay for performance

Example: Eighty percent of Executive’s at-risk pay is based on production volume as this determines shareholder return.  A minimum threshold of x was required before any payout in accordance with the Business Plan.

Demonstrate Sound Governance

Demonstrate Sound Governance

  • Adequate measures and internal governance processes should be in place to ensure remuneration practices do not expose the company to risk.

Tips…

  • Establish and engage regularly with an independent Remuneration Committee
  • Undertake regular review of rem practices to ensure risks continue to be mitigated
  • Reassure stakeholders as to the extent risk management measures rather than assuming they understand.

Example: Don’t simply refer to the Remuneration Committee, instead identify its members, note their independence and include (or at least make reference) to its charter.

Embrace Transparency

Embrace Transparency

  • Strike a balance between transparency and simplicity.  Too much detail risks confusing shareholders while too little may provide insufficient justification for rem practices.
  • Remaining in contact with stakeholders throughout the year allows you to seek their input regularly, keep them up to speed and provide clarification meaning the contents of the report will be more easily digested and not a surprise.
  • Don’t simply state the details, explain them.
  • Place yourself in a ‘new comers’ shoes and asking yourself what else might the need to know or where can I be more clear can help.

Example: “A formula was used to determine STI payments” is very vague and should be replaced with a description of the formula.

And Finally, Look Back to Look Forward

It’s imperative that you use comprehensive benchmarking to inform your future executive remuneration design decisions.  When drafting your Remuneration Report you can then also provide detail as to the nature and rationale of any market data used for comparison purposes to give shareholders confidence in the selected amounts of fixed remuneration for example.

Don’t rely simply on the dollar for dollar comparisons with other executives, make use of comprehensive benchmarking which factors in company performance, industry specifics, company size and other important factors as with our Performance Pay Index.  That way you’ll be providing stakeholders with sufficient information to understand the benchmarking process and its robustness.

Knowing where to start when managing executive remuneration can be difficult – we’re here to help.

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