Risk and remuneration

  • Date:01 Aug 2013
  • Type:Company Director Magazine
Dr Ulysses Chioatto outlines the risk and remuneration issues directors should address ahead of the fast-approaching AGM season.


The "two-strikes" rule is now well entrenched and this year’s annual general meeting (AGM) season will soon be upon us, with some holding their breath and others sighing in relief.

When planning for the season, directors will find that setting aside time for engagement with stakeholders is practical and useful. In our regular dialogue, chairmen of boards and remuneration committees tell us that engaging institutional investors can be a challenge for many reasons. For example, those who have recently been catapulted into the ASX 300 might be unfamiliar with investors’ expectations. This can be a bit like being an extra on 300 Spartans, with lots of noise, feelings of exposure and projectiles coming at you from all sides. Other challenges include working out who to speak to and what issues to cover, and whether discussion should involve more than just the remuneration report.

Engagement differs depending on whether you are meeting industry bodies, research analysts, regulators, the Australian Securities Exchange (ASX) or directly institutional investors or their advisers, such as Institutional Shareholder Services (ISS). On a daily basis, directors tell us they find talking to us a useful conduit or bridge to communicating most efficiently to their institutional investors, especially those companies with a global business and investor base.

What are the issues?

The ever increasing use of the two-strikes rule for purposes other than displeasure with the structure of the remuneration report is certainly focusing everyone’s attention. The focus can be narrow: balancing cash and short- and long-term incentives for key management personnel and non-executive directors. The tip here is to keep in mind how your remuneration report aligns with shareholders’ interests. This alignment, and disclosure of the rationale behind how you’ve structured your remuneration, are the two key ways of building good shareholder relations.

Consider how you are delivering value to the shareholders, the composition and skill-set balance on your board, the relationship between you (the board) and your management team and so on. The main communication tools you have available are your Notice of Meeting and, of course, your annual report. Striking a balance between simplicity and disclosure can be difficult.

In making voting decisions based on our recommendations, super funds and fund managers take the various considerations listed above on board. Our analysis helps achieve greater clarity and transparency, but only if your Notice of Meeting and annual report are set out clearly and transparently. In analysing hundreds of these documents, the "good, bad and ugly" stand out.

In our more than 200 pre-AGM season meetings with chairmen of remuneration committees and boards, they confirm that engaging us provides them not only with a conduit to better communicate with their institutional investors, but also helps in the crafting of the meeting agenda. And, when engaging other stakeholders – such as industry bodies, regulators and analysts – it also helps them to get to the issues promptly.

Risk management

You also need to consider how you address risk management. I hear you yawning! Yes, that old chestnut. Some companies, such as Macquarie Group, extensively address risk in their annual reports and even link it to remuneration. The "yawn factor" is understandable as there are three flavours of risk. They arise out of the ASX, Corporations Act 2001 and the Australian Prudential Regulation Authority. There are also three approaches I will mention but not elaborate on: the ISO 31000 standard, the Committee of Sponsoring Organizations (COSO) framework and the heavily quantitative-based credit/market risk models and their poor cousin, operational risk (which are Basel II and III driven). If you are dual regulated, you will know risk in all its guises. ASX 300 companies not in the financial services sector that simply look at risk reporting in terms of "if not, why not", based on Principle 7: Recognise and Manage Risk of the ASX Corporate Governance Council’s recommendations, struggle to adequately address their main business risks. Most of Principle 7 is very poor reporting indeed.

Overall, hardly anyone addresses the various risks set out in the principles. Yet, at the same time, market announcements abound about risks evidently not being adequately managed.

It’s vital to join the dots between risk and remuneration. If risks are not identified by your management team and your board is unaware of them and your company gives the market a surprise, then don’t be surprised by the adverse reaction from shareholders at the AGM.

Dialogue and engagement

Further enhancements to our engagement/dialogue model with boards is underway to provide more positive interactions that enhance our reports to our institutional investor clients.

For example, in the 2013 season, ISS is providing views on matters likely to gain prominence in the 2014 season.

We maintain an open approach to dialogue and engagement and strongly oppose a season "blackout". In many cases, we maintain dialogue "down to the wire" as required, although this can be restricted by natural time constraints as the AGM season heats up.