The outcome of the upcoming US presidential election may have adverse effects on global and national trade agreements, writes David Uren.
As boards adapt to a new community mood during the COVID-19 pandemic, the sensitive issue of executive remuneration has become more controversial. Unemployment is at levels not seen for decades. Many workers, including CEOs, have kept their jobs, but are on reduced pay. Shareholders have watched dividends fall and share prices plummet. Many companies are threatened with insolvency.
It is possible that in a year or two, executive pay will return to an upward trajectory. But it’s more likely that the COVID-19-driven recession will trigger a fundamental pay rethink as boards adapt to a new world.
SEEK chair Graham Goldsmith FAICD observes that while the sudden economic crisis hasn’t yet made the executive pay question clearer, “it has made the director community stop and think”.
Other downturns have had that effect. Ed John, executive manager, governance, engagement and policy at the Australian Council of Superannuation Investors (ACSI), notes that the global financial crisis in 2008 ultimately expanded boards’ discretion on executive pay issues and slowed the growth of fixed remuneration.
Right now, boards “are likely to be conservative in relation to fixed pay”, says executive pay consultant John Egan, founder and CEO of Egan Associates. “In public company environments. boards need to be very mindful of the expectations of their investors.” Few directors are focusing hard on the long-term future of their executives’ pay packets. Most have put their attention towards getting their companies through the initial shock of the economic downturn and surviving beyond that.
“I would expect restraint to be the name of the game for some time,” says Daniel Smith, general manager of corporate governance firm CGI Glass Lewis. He singles out Qantas as a smart early mover on executive salary once COVID-19 hit. Alan Joyce AC, the airline’s CEO, announced in March that he’d forego pay for the remainder of 2019–20. Other CEOs have followed suit, especially in hard-hit industries, handing themselves pay cuts to mollify directors and shareholders.
John Stanhope AM FAICD, Deakin University chancellor, chair of the Port of Melbourne, and non-executive director of AGL Energy, says he has observed a number of approaches. These range from executives who have achieved their KPIs and as part of their contractual conditions, who reasonably expect to be paid, to others who have achieved their objectives, but voluntarily determined they would forgo their bonuses and even pay increases. “There are a lot of combinations of things occurring, but mostly corporations and executives are recognising these are different times and there needs to be some give and take,” he says. “For boards, it really is a balancing act because they do have to be cognisant of the competition for talent. I’ve held the view for many years that if senior executives create value for the organisation, they ought to be rewarded accordingly.”
“We expect to see executives be prepared to waive potential salary increases and reduce bonuses for the forthcoming financial year, particularly where the issuer has had to cut dividends and/or reduce workforce pay or employment levels,” said Natasha O’Connor, Glass Lewis research manager for Northern Europe, in May. “Alignment is key. The executive experience should not be more favourable than that of shareholders or the workforce.”
The longer-term question is: as the economy emerges from the pandemic, will restraint linger or will the normal pattern resume?
In November 2019, the Australian Bureau of Statistics reported that full-time workers in Australia earn an average of $1633.80 a week, roughly $84,950 a year. The chief executives of Australia’s ASX 100 companies received an average annual income of $5.66m in the 2018 financial year, according to the Australian Council of Superannuation Investors. That works out at around $108,846 a week before tax.
Uncertain and flexible
Even before COVID-19, executive pay was an issue as stakeholders of all stripes pressured them for better performance. Meanwhile, one 2017 poll by the Australia Institute suggested around four in five Australians thought most chief executives were overpaid.
Stanhope says the “pub test” is a tricky one. “Do executives get too much money?” he asks. “If you look globally, Australian executives are probably rewarded reasonably, but someone in a pub will always say they are paid too much.”
Stephen Walmsley, a KPMG partner advising ASX 100 boards, says directors have spent “a ridiculous amount of time” on executive pay. However, as time goes on, emergency thinking will give way to longer-term considerations. Walmsley argues that as some parts of the economy recover — for example, mining and infrastructure — and others lag behind, the laggards risk having their best executives picked off.
Beyond the principle of short-term restraint, uncertainty currently reigns. “At the moment, my experience with boards is they are going through the process of what to do next,” says Egan.
Adds Goldsmith, “People are still in the mode where they’re very much assessing what is the right thing to do.”
O’Connor is cautious about predicting how the executive pay landscape may shift, suggesting remuneration committees “may choose to delay equity grants until market volatility has stabilised”, but adds she’s “cognisant that timeframe is not entirely clear”.
Amid all this uncertainty, experts unsurprisingly suggest that boards stay flexible as they assess the changing situation, keeping watch for the next 12 months and beyond, and being ready to respond quickly to changing attitudes and circumstances.
In its recent paper on the executive pay response to COVID-19, consulting firm Korn Ferry advises compensation committees to “commit to monitoring developments during the year and revisiting decisions made”. If those decisions no longer make sense, committees may need to make “mid-course corrections”.
The Korn Ferry report argues that in the context of such a volatile environment, what worked in the past “is no longer a reliable guide to inform future decision-making”. It also says that some compensation committees are already looking at not just tweaking their existing settings, but “more sweeping adjustments to the structure and mechanics of executive pay programs”.
The report encourages directors to “consider how your company will likely need to evolve to compete on a radically different business landscape”.
Walmsley encourages directors to think beyond what is familiar. “Things that might have been key measures of performance before the pandemic are not necessarily the things that are going to face us in the next three, four or five years,” he says. Boards should be “really thinking about what are the important drivers of business recovery”.
Adapting executive pay for the times
Deciding on a remuneration response to COVID-19 impacts has been like taking an exam where there is a new test format and no-one has the benefit of past papers, says consultancy Guerdon Associates.
In the August profit reporting season, 77 ASX 200 companies announced a negative remuneration adjustment for key management personnel.
Guerdon says the following factors will dictate companies’ executive pay actions:
- Are they listed? If not, the variety of actions that can be undertaken is broader, as there will be no proxy adviser and investor guidelines to consider, or AGM votes on pay reports.
- Is their cash position desperate, constrained or comfortable?
- What happened to the bottom line? COVID-19 is highly selective in its misery. Airlines were impacted differently to banks, which were impacted differently to healthcare and biotech companies.
- What happened to stakeholders? These are shareholders, employees, governments, customers, suppliers.
- How good has their remuneration governance been up to this point?
- How robust is the executive pay framework to cope with uncertainty, results volatility, attraction, retention, and focus on results that matter to stakeholders?
Source: Guerdon Associates
The rise of equity
For many of the people considering the future of executive pay, 2020 underlines the need to put more senior executives’ pay at risk. In the now-familiar language, many stakeholders want to make executives act more like owners whose fortunes rise and fall with a company’s value. “The issue is coming up time and time again”, says ACSI’s John. “We saw a push towards equity following the GFC, and it might be even stronger after COVID-19. Cash-based, long- and short-term incentives may reduce even further or disappear from a number of companies’ remuneration plans.”
At CGI Glass Lewis, Smith expects to see during the next few years “probably a fair amount more equity as a proportion of the total remuneration package”. He doesn’t mean adding equity to existing pay; he means raising the proportion of total pay doled out as an equity stake, with a smaller fixed base. Smith sees a possible future where “fixed pay isn’t seen to be as important”.
Walmsley argues that the past two years have already seen a “material reduction” in base pay among the ASX 100, accompanied by higher at-risk pay and equity grants. In the US and UK, in response to concerns that CEO salaries are growing at an unfair rate and leaving workers behind, companies are required to report the ratio of CEO pay to median worker pay. The ALP has called for the same requirement in Australia.
Egan has been looking at proposals from companies that have cut executive pay and bonuses, but want management to have an incentive to rebuild. He sees one alternative to share issues being large numbers of options, exercisable at a premium during the next two to five years if management teams can take the share price to double its pre-pandemic level. SEEK has “gone out on a limb”, says Goldsmith. Its management team receives a 50/50 mix of base pay and deferred equity, options and rights, with restriction periods from two to four years. This is similar to a scheme that Telstra chair John Mullen has mused on: “A fixed salary commensurate with the difficulty of the role, with maybe one half in cash and one half in shares locked up for five years”. Goldsmith believes this approach, aligning the interests of executives and shareholders, may become more popular.
O’Connor points out a dangerous trap for remuneration committees: awarding new long-term incentives calculated by reference to depressed share prices. If these share prices bounce back, executives could reap an unearned bonus. Any payouts, she notes, should pay heed to “the wider stakeholder experience” where dividends may be far below their pre-2020 level.
Todd Sirras, managing director of US executive compensation consulting firm Semler Brossy, suggests calculating share prices for future equity awards during a longer period of time to “help avoid unintended windfalls from this year’s equity awards if the stock market quickly recovers”.
For boards it really is a balancing act... I’ve held the view for many years that if senior executives create value for the organisation, they ought to be rewarded accordingly.
History indicates that when nations face outside threats they expect to see sacrifice from their most prominent business leaders. For example, a US National Bureau of Economic Research paper suggests “executive pay rose much less than the average earnings of the workforce from 1940–49”. The multiple dropped even after the end of WWII, and by 1949, leading US executives were paid just 17 times the average wage.
Some analysts see the possibility of another such recalibration in the quantum of executive pay beyond 2020. Remuneration is “a hygiene factor more than a motivator”, says KPMG’s Walmsley. The majority of senior executives, he says, would take the view that “we work for companies because we like what they stand for”.
Semler Brossy takes the view most executives are not primarily working to get as much money as they can. Sirras argues that for executive pay after COVID-19, the question of a change in direction is “the only question, in many ways”.
The firm’s view is that most executives feel they’ve made enough money. “The money is just a means of keeping score,” says Sirras. “It’s a means of having me feel good about what I do.” He argues the crucial step for boards looking to recruit talent in tough times will increasingly be to “make it about more than just money”.
In the long term, he doubts some boards will have much choice. After COVID-19, companies will need to better prepare for the next public health crisis, and that will mean bolstering balance sheets with more cash and other liquid investments. Higher public debt may put an end to corporate tax cuts. These factors point to smaller returns that shrink equity’s attractions.
Sirras is not arguing that boards should rush into changing the pay of their leadership team. “It’s not something to be hasty about,” he says. As a director, “you’re still dealing with individuals and the incentives you’re providing for doing their job”.
He also points out the huge inertia that executive pay patterns build up. “It’s difficult to be first. What’s happened in the past 10 years has been quite a bit of homogenisation of executive pay across companies.” If executive pay changes, he adds, the move will probably come from “brave boards and brave companies, or companies in a position where they have to make a change”.
Ahead of this AGM season there are signs of a significant shift. In August, Bendigo and Adelaide Bank announced plans to scrap short-term bonuses for key executives as part of remuneration overhaul, saying cash incentives were incompatible with its strategy and risked poor culture and behaviour.
Telling the story
Whatever happens, the stakeholders and directors Company Director spoke to agree that at a company level, change needs to be carefully communicated. “One of the things that will make executive pay less of an issue... is clarity in communication and expectation,” says Walmsley.
Smith calls executive pay “a communication device” and says directors must be clear why they’re using it. “What story are you trying to tell your executives?” he says. “What story are you trying to tell your investors, employees and the broader community about how and what you pay your executives? If that story doesn’t hold up under scrutiny, you might need to change the narrative.”
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