A state of Flux

Wednesday, 01 February 2017

James Dunn photo
James Dunn

    The recent reporting season has placed a number of companies in the spotlight and raised some important issues about the future of the traditional annual general meeting, writes James Dunn.

    In the calendar of Australian companies, the annual general meeting (AGM) season in October–December – for companies reporting on a June 30 financial-year basis – is well entrenched as the last, exhausting act of the year.

    For the 2,200 companies listed on the Australian Securities Exchange (ASX), the AGM can be either a tiresome piece of compliance or a highly engaging interaction between the company and its owner investors. Undoubtedly, there is increasing pressure on the companies to make it the latter.

    For the media, AGM season can provide spicy headlines, especially in light of corporate Australia’s “two strikes” remuneration vote rule: if a company’s remuneration report receives two consecutive “no” votes of 25 per cent of shareholders or more at AGMs, it triggers a vote the following year on whether all the directors will need to stand for re-election.

    Remuneration report votes have increasingly become the focus of media coverage of AGM season – and in November, when the nation’s largest company by market capitalisation, Commonwealth Bank of Australia (CBA), suffered an historic “first strike”, it ensured that remuneration would be the story of the 2016 season.

    Shareholders of the banking giant – worth $145 billion on the stock market – not only voted down CBA’s remuneration report by a 51 per cent majority vote, they also forced the withdrawal of another motion asking for approval of a new bonus package worth up to $4 million for chief executive officer (CEO), Ian Narev. The unprecedented humbling was reported as harbinger of a sweeping revolt against excessive executive pay in Australia.

    But in reality, the CBA vote – albeit sensational – was an increasingly rare example. According to research by Investor Weekly magazine, about 9 per cent of companies in the S&P/ASX 200 index received a vote of more than 25 per cent against their remuneration report. That figure is down from a three-year average of about 14 per cent, had the rule been hypothetically in force from 2008 to 2010. In raw figures, only a small number of S&P/ASX 100 index member companies received a strike against their remuneration report.

    “The CBA strike was remarkable because it’s a relatively high-performing company,” says Ed John, executive manager of governance, engagement and policy at the Australian Council of Superannuation Investors (ACSI). “There’s definitely been a long-term trend of rising willingness to vote against remuneration where the shareholders see it as not relating to performance.

    “It’s a global trend – institutional investors spend a lot of time looking at remuneration because it’s a useful insight into how management and the board interact, and how the company is thinking as its strategy unfolds,” says John.

    Other high-profile “strike” votes included CSL, Goodman Group, Boral, AGL Energy, Bellamy’s Australia, Spotless, Mortgage Choice, Carsales.com.au, Woodside Petroleum, Cover-More and Metcash.

    Investors only vote down remuneration reports when the pay and incentives fail to match up with financial returns, says Vas Kolesnikoff, head of Australia/New Zealand research at Institutional Shareholder Services (ISS). “A company that is showing value to shareholders doesn’t have much to worry about. When the disclosure is poor, and the results are not necessarily there, the shareholders will exercise their right to not accept it. That’s the biggest issue, especially when it’s tied up with bonuses, incentives or equity grants that are linked to non-financial, subjective measurements – the so-called ‘soft’ targets.”

    In many cases, says Kolesnikoff, the targets are not only “soft”, they are actually related to outcomes where people are “simply doing their jobs.”

    “We saw a chief financial officer’s (CFO) bonus based on getting a Eurobond issue away: that’s generally part of the CFO’s job. We saw bonuses for ‘improving diversity’. That was the issue with CBA: they were bringing in quite a lot of subjective targets – 25 per cent of the CEO’s long-term incentive would have been linked to improving ‘diversity and inclusion, sustainability and culture.’

    “That was purely subjective: it had to be determined by the board. Shareholders want to see a better culture, sure, but it should be there anyway, and it’s part of the CEO’s job, so why is it in the bonus?” Kolesnikoff says. The remuneration changes that would have introduced new performance hurdles relating to people and culture were withdrawn by CBA before its AGM.

    When it is all boiled down, Kolesnikoff says, remuneration and bonuses and performance targets are about achieving a result for shareholders that’s in their interests – which means creating long-term shareholder value. “If the board is able to present cleanly and concisely and disclose the performance targets, and how they are aligned with shareholder interests and produce shareholder value, and actually do so, from what I can see, shareholders are very happy to support the boards,” says Kolesnikoff. “But companies and boards have to understand that in 2017, investors are not willing to take what the companies and boards present to them as gospel.”

    Remuneration in focus

    The remuneration report vote has become important because the management of executive pay is “one of the few insights that investors get into board competence,” says Dean Paatsch, CEO of proxy advisory firm Ownership Matters.

    “Remuneration is important because incentives determine behaviours, and perverse incentives can destroy value. The proliferation of ‘soft’ targets in short-term incentives (STIs) is nothing new, but the focus on the more ludicrous schemes is welcome. Investors get no binding authority over awarding bonuses [for soft targets] but at least we get to laugh at them now,” says Paatsch.

    The focus on remuneration has been a continuing theme of AGMs over the last few years, and that will continue, says Elana Rubin FAICD, director of Mirvac Group Limited, Touchcorp, ME Bank, Transurban Queensland and Victorian Funds Management Corporation (VFMC). “While there has been some winding back of remuneration, investors – quite rightly – want to ensure remuneration structures are aligned to longer term performance.”

    Rubin says the resistance to bonuses and equity grants tied to non-financial performance metrics shows that boards need to better explain the basis of the measures. “If one believes that culture truly does matter and is an important (and differentiating) factor which leads to improved company performance, then it is an appropriate metric to include.

    “A positive arising from the recent AGM season is the opportunity for a discussion about whether executive remuneration structures have become too complex and whether simpler models should be developed, and what they could look like,” she says.

    Graham Goldsmith FAICD, director of SEEK Limited and Djerriwarrh Investments Limited, and Chancellor of Swinburne University of Technology, says each strike vote seemed to have “individual issues relating to the reasons there was a negative vote.”

    “There are a number of issues around remuneration, including absolute levels, the role of short-term incentives, and the use of non-financial metrics,” says Goldsmith. “Looking at each of these in turn, absolute levels are clearly an issue for some investors and companies need to explain their particular circumstances and why specific levels might be justified. CEO pay levels are at very high multiples of average workers’ pay, and when the performance of a number of larger companies has been mediocre, shareholders in those companies are asking, ‘are we getting value for money?’”

    Goldsmith says some companies have moved away from STIs, as the criteria for them being awarded “are often inconsistent with managing organisations for a long-term focus.” On non-financial metrics, he says there should be a debate about whether financial metrics are inputs or outputs to performance. “Generally, they are outputs in my view. I think non-financial metrics around culture, people and customer service are highly relevant, because all organisational performance starts with culture and if you don’t get that right then an organisation is bound to get into trouble at some point,“ he says.

    Kolesnikoff says companies are getting better at ongoing engagement and communication with shareholders, reducing the likelihood of a shock negative vote at the AGM. “They are communicating much more with their investors, particularly institutional shareholders, and with the proxy advisers, about what they’re intending to do. That’s good, because when shareholders understand the company’s point of view, they can then assess the proposals on their merits. But if a proposal won’t fly, the investors will make this very clear – and the company may well decide not to take it to the AGM.”

    Shareholder engagement

    Australian company boards are pioneering an effective structure of shareholder engagement, says Paatsch. “It is now commonplace for directors to meet regularly with a wide variety of buy-side investors on ‘governance roadshows’ where all manner of topics, not just remuneration, are canvassed. The great thing about this is that the relationships that are formed provide great intelligence and inputs on issues of strategy and feedback on performance that can be useful,” he says.

    Kolesnikoff argues that communicating with proxy advisers and investors before the AGM means companies are much better prepared to argue their case.“The media is attuned to cases where there is potential backlash from proxy advisers or shareholders, and there is plenty of publicity. We would say that this produces better outcomes – but some companies will still take the chance at the AGM.”

    Condom maker Ansell was facing a second strike at its October 2016 AGM – and a spill of the board – but decided to write to its shareholders to explain the reasoning behind its remuneration and incentive policies, and subsequently avoided an investor backlash. Kolesnikoff argues that the more of this, the better.

    Such communication does not focus solely on remuneration. Last year Lendlease proposed to amend its constitution by capping its board numbers at 12 and tightening the shareholder support level for director nominations. Proxy advisers and institutional shareholders told the company the proposal would not be supported, so the company withdrew it before its November AGM.

    In contrast, Sims Metal Management took constitutional amendments to its AGM that included a resolution capping the number of directors at 10. The proposal was defeated, and the company copped a first remuneration strike for good measure. “Shareholders don’t want to beat companies around the head for the sake of it, but on things like director amendments, they want to keep their options open,” says Kolesnikoff. “As with remuneration, the fact that the company wants to do something is no longer a good enough reason for it to pass.”

    The AGM – is it still fit for purpose?

    Although an essential legal requirement for public companies, the annual general meeting (AGM) can be a sterile piece of corporate theatre for many – and an expensive production for smaller companies.

    According to a survey of 700 meetings by share registry Computershare, AGM attendance fell by 25 per cent between 2005 and 2015. While remuneration “strikes” receive sensational media coverage, the fact is that AGMs are losing relevance for many investors, and they’re voting with their feet.

    “The relevance of the AGM is that it has a public element to it – it doesn’t allow issues to be kept private,” says Vas Kolesnikoff, head of Australia/New Zealand research at Institutional Shareholder Services (ISS).

    “If the AGM concept were ever removed, and with it the ability for the shareholders to go to an AGM and ask questions of the board, that would be a pretty serious issue.”

    Graham Goldsmith FAICD, director of SEEK Limited and Djerriwarrh Investments Limited, and Chancellor of Swinburne University of Technology, expects AGM attendance to continue to fall as retail investors increasingly hold their exposure to equity through mutual funds or exchange-traded funds (ETFs). He says it is right to question whether the current format is appropriate.

    “However, the AGM still serves a function for shareholders as it is the only formal public opportunity for boards and management to be held accountable for their actions. While shareholders may not use AGMs this way very much, they still provide a venue for shareholders to require boards to give an account of their stewardship – and in that sense, they provide a discipline on boards.”

    Lost direction

    Goldsmith says the “fundamental purpose” of the AGM was as a forum for shareholders to hear about the progress of their company, have an opportunity to ask questions, vote on director elections and the financial accounts, and hold directors accountable for their stewardship of the company.

    “Subsequently we have dropped the requirement to vote on financial accounts and added in remuneration. The matters considered by way of vote these days are normally director re-election and remuneration issues.

    “I can’t see there being a change in that, but perhaps the manner in which voting occurs now – the majority of major companies have moved directly to a poll, the vast majority of the votes for which are received before the AGM – does bring into question the actual format and usefulness of our current AGM approach. I’m not sure of the answer at this point, but evolution could lead us over time to a different form of meeting.“

    Hybrid solution

    Technology is finally catching up with AGMs, which require physical presence. But with CBA holding its 2016 AGM in Perth and National Australia Bank holding its in Adelaide, many shareholders cannot be present. While many companies webcast their AGM proceedings, offering the ability to vote remotely has proven tricky for Australian companies hampered by legal hurdles.

    But change is on the way. In November 2016, super fund administration and share registry company Link Group held the first “hybrid” AGM for an S&P/ASX 200 company incorporated in Australia: using Link’s proprietary technology, the company’s shareholders could either participate in person at the AGM and vote using the LinkVote app or participate online. Of the votes cast during Link’s AGM, 16 per cent were cast online, 50 per cent were cast through the LinkVote app and 34 per cent were paper-based.

    “You hear a lot of grumbles from company boards that the AGM is going the way of the dinosaur, but we think about it differently,” says Link Group managing director John McMurtrie FAICD. “Technology is providing us with new tools and a genuine opportunity to engage with investors and bring the AGM to life.

    “Boards are facing a real challenge to keep AGMs relevant for shareholders and I think Link has demonstrated that we have a real opportunity to modernise the AGM process and develop a more engaging forum for shareholders. Thanks to innovations such as this, it is clear that the AGM is here to stay,” says McMurtrie.

    Any form of technology that widens access to the AGM should be welcomed, says Kolesnikoff. “We just need the public forum. Whatever the technology, anything that allows an investor to turn up – in person, or virtually – and respectfully ask their question and have the issue addressed, is a positive.”

    But Diana D’Ambra MAICD, chair of the Australian Shareholders’ Association (ASA), argues that remote access is not a real improvement unless the format of the AGM itself is changed. “Of course, virtual attendance is better than no attendance, but it doesn’t help if the AGM is backward-looking and dry, and the company is purely ticking the legal compliance boxes.

    “Companies need to make their AGMs more forward-looking, where they’re communicating their strategy to deliver financial performance. Investors want to understand the strategic intent. That actually ties in with the issue of remuneration, because if shareholders understand the strategic intent and delivery, they’re far more likely to understand the linkage to remuneration.”

    Whatever the medium in which the AGM is delivered, D’Ambra would like to see more executives and directors present, and engaged in discussion. “All too often, shareholders only hear from the chair and the CEO. At the very least, directors with portfolios – heads of the audit, remuneration, nominations, sustainability committees – should be available to speak and answer questions. The same goes for divisional managers. That can create real and valuable discussion.”

    Given the need to streamline the actual AGM in time, D’Ambra would also like to see companies offer pre-AGM investor sessions, or information sessions at regular intervals through the year. “Some companies are doing this, Telstra being a prime example. That’s good, because the more chances the shareholders have to eyeball the directors and executives, and question them, the better,” she says.

    Companies face the music

    When a bank chair opens an annual general meeting (AGM) with a conciliatory address that cites growing distrust of big business and political institutions – and speaks of these issues as pressing obstacles for the bank to overcome along with more traditional banking and economic concerns – as ANZ chairman David Gonski AC FAICDLife did at the bank’s December 2016 meeting, you know that companies are listening, at least for public show, to a groundswell of community concern.

    Cynics might say that given a string of scandals, the big banks need to make a mea culpa – and later in the meeting, ANZ CEO Shayne Elliott MAICD made a point of saying, “we do ourselves no favours when people hear about some of our well-paid staff indulging in completely unacceptable workplace conduct.” But companies’ acknowledgement of “reputational” issues is on the rise, says Ed John, executive manager of governance, engagement and policy at the Australian Council of Superannuation Investors (ACSI) – and rightly so.

    “This is very much an emerging trend, it’s driven by social media, and it’s an increasing focus on companies’ ‘social licence to operate’. That’s influencing companies, and we’re seeing a lot of boards spend more time on reputational issues, and trying to understand the broader view of companies as having a wide range of ‘stakeholders,’” says John.

    “Much of this is around ESG (environmental, social and governance) issues, but there is also a great deal of debate around inequality – economic and social – and the role that companies do and can play in this. A lot of directors may not have considered these issues, but if they haven’t thought about them already, they should start, because it is going to be an increasingly important feature of corporate life – and increasingly, of the AGM, because it’s the company’s major public event.”

    Although these issues can attract heavy coverage at the time of the AGM – particularly if there are dissident activist shareholders inside the meeting or protestors outside it – they are now a permanent feature of corporate life, says John.

    But he sees in the newer generation of directors a much greater willingness to look beyond the mindset of compliance with the basic legal requirements. “Boards have generally done well in adding to their composition people who think about these things, rather than just be reactive when issues are raised. That ties in with the whole debate about diversity and the make-up of boards. We’re seeing far more diverse boards, but there is still a lot of work to be done in that area,” says John.


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