Connecting with investors on pay

In the wake of the recent AGM season, Domini Stuart discovers communication still counts most when reporting on executive remuneration.

In 2011, 52.9 per cent of Pacific Brands’ shareholders voted against the board’s remuneration report when it emerged that the CEO and other senior executives had received short-term cash incentives (STIs) as high as $910,000 despite posting a $132 million loss.

“Executives increasing their pay when shareholders are getting nothing is always going to create friction,” says Ian Matheson FAICD, CEO of the Australasian Investor Relations Association.

Before the vote, chairman James MacKenzie FAICD responded to pre-submitted concerns by telling shareholders targets had been missed by only a narrow margin and for reasons beyond the executives’ control. A significant restructure had also been completed a year ahead of schedule.

‘‘What we should have also emphasised was that the delivery of the transformation program … was a critical consideration in the board’s decision to open the gate for the payment of STIs,’’ he said.

He was right. If one lesson has been learned since the introduction of the “two-strikes” rule two years ago, it is the importance of communication.

“We’re hearing many chairmen have got the message that they need to talk to the investment community and proxy advisers and that there’s been a significant increase in that engagement,” says Matheson.

Learning Curve

Guerdon Associates director Michael Robinson MAICD agrees that many directors have been on a rapid learning curve.

“Boards are now more knowledgeable about what is acceptable and what is not, and directors are much more sophisticated in their engagement timing and process,” he says.

“This shows in the declining level of ‘no’ votes and proxy adviser ‘no’ recommendations. Average S&P/ASX 300 support levels have increased from the low 90 per cents to the mid and high 90 per cents this season. This is a major improvement.”

But is the “two-strikes” rule making companies so cautious that they are all opting for the same, bland model?

“Boards know that, all other things being equal, when a long-term incentive uses a relative total shareholder return (RTSR) and an accounting-based performance measure, the remuneration report will almost certainly get a tick from the proxy advisers and 95 per cent support from shareholders,” says Pru Bennett, a director of BlackRock’s corporate governance and responsible investment team for the Asia Pacific Region.

“We don’t vote against remuneration reports with a structure like that, but we will voice concern if we feel it’s not the best model for the company.

“Our preference is for boards to develop their executive remuneration structures based on their knowledge of the business, their strategy and their internal plans and then communicate that clearly to shareholders.”

AMP Capital is on record as wanting to see an RTSR measure in companies’ performance hurdles, but would not automatically vote against a plan without one.

“We think it makes good sense for a component of senior executives’ bonuses to be related to the company’s relative share price performance, but if companies have chosen another hurdle, we just need them to explain what makes it more appropriate for them at this particular time,” says AMP Capital’s corporate governance manager Karin Halliday GAICD.

“We know one size doesn’t necessarily fit all.”
Avoiding problems could be as simple as reading the appropriate guidelines.
 
“Directors should be cognisant of the various corporate governance guidelines and ensure the issues raised in these guidelines are adequately addressed when issues are presented to shareholders for voting,” says Bennett.

“Our guidelines don’t say: ‘You have to do it this way.’ But they do spell out what we look at from a governance perspective and where we would expect an explanation. In most cases, we’re happy to support a different approach if there’s a sound rationale.”

Some boards are making an effort to release their directors’ report at the same time as their full-year results. “This gives time for any contentious issues in the remuneration report to be discussed with the proxy advisers and the investment community well in advance of the AGM,” says Matheson. “This could help reduce the move towards conformity.”

Some, such as Telstra, are also testing different ways of reaching their shareholders.

“For the past two or three years, Telstra has held a series of retail shareholder information meetings around the country ahead of the AGM,” continues Matheson. “I’m told it got almost twice as many people at those than at the AGM itself.”

Where Influence Lies

In shaping their communications, directors need to be very clear about where the real sources of influence lie. “They should know who is on the company’s share register, the split between domestic and offshore institutions and whether the offshore component is mainly Asian, American or European,” says Matheson.
 
“Proxy advisers have different levels of influence within those regions.”

There are also differences in policy between the advisers themselves.

“They may not appear stark, but they are nuanced enough to result in differing recommendations on how to vote,” says Robinson.

“In addition, directors should be aware that while a high proportion of institutional investors, and particularly overseas investors, will just follow proxy advisers’ recommendations, many act in accordance with their own guidelines, which can also vary in nuanced ways from those of the proxy advisers.”

AMP Capital subscribes to only one proxy adviser, but Halliday recognises how these differences could create confusion.

“A couple of years ago, a company that had received a first strike came in to talk to us and then went on to speak to other institutions,” she says.

“It told us later that some wanted to see RTSR, some wanted to see three-year hurdles and some wouldn’t vote for anything other than a four-year hurdle.

“It was quite interesting to hear what some companies have to grapple with, particularly in terms of remuneration.”

However, the companies that have suffered most from remuneration report “strikes” are less likely to be the larger listed entities covered by the proxy advisers than smaller-cap companies with a large retail shareholder base, particularly where there is a dominant shareholder who disagrees with the board’s policies.

“There have been a number of cases where the vote on the remuneration report has been influenced by non-remuneration issues,” says Robinson.

Others are new to the market or among the ASX 300 for the first time.

“These companies may have been operating in an environment where there isn’t quite the same focus on remuneration or their shareholder base might have changed significantly,” says Matheson.

“If their directors aren’t experienced, they can struggle to adjust to what appears to be a new set of rules.”

Overwhelming Interest In Pay

Some commentators are concerned that the “two-strikes” rule is forcing companies to focus on remuneration at the expense of other factors that drive long-term value for shareholders.

“While this is true for some investors, I’ve found the increased interest in remuneration has the added bonus of opening the door to more wide-ranging conversations,” says Halliday.

“When a chairman comes in to discuss the upcoming resolutions for the AGM, we do talk about remuneration, but we also discuss issues like what’s happening with the board, succession planning for the CEO, strategic issues, risk management, environmental and social issues and supply chain risk, so we have an opportunity to delve deeper.

“But at the same time, analysing the remuneration report helps us build a more complete picture of the companies we’re investing in.

“For example, if a CEO’s pay is very high relative to other industries or other people in the organisation, it raises questions about the power of the CEO and possible retention issues. Performance measures, and particularly STIs, indicate where a company’s immediate priorities lie. The report also says a lot about how clear the organisation is prepared to be in terms of how much it pays and the basis on which that’s calculated.

“Some companies still behave as though that is not shareholders’ business.”

There’s a fine line between confidentiality and transparency and there can be a gap between what companies are prepared to say and what investors want to hear. But that is no excuse for perfunctory communication.

 “Some directors don’t understand that we really do read these documents and are making judgements about the board on public disclosure,” says Halliday.

Anthony Tregoning, managing director and founder of Financial & Corporate Relations (FCR) (Twitter @FCR_Social), expects to see a shift in emphasis as boards learn their lessons about remuneration.

“This year, David Jones, Leighton and Newcrest have been criticised for issues other than remuneration and I think that suggests a broader focus,” he says.

“There’s no doubt that many companies do need to communicate more clearly on matters such as strategy, corporate culture, environmental standards, community involvement, research and innovation. But I do think there’s a risk that institutional investors will start trying to influence strategy. The final decisions must always remain with management and the board.”

Most directors and CEOs are articulate and used to communicating with customers and employees as well as key shareholders and analysts.

Yet, as Tregoning points out, we frequently hear them criticising the investment market for underestimating the significance of an announcement or undervaluing the company’s shares.

“Some investors are basing their decisions on a relatively superficial view of a company. Is this the investor’s fault or the company’s?

“We believe it’s the latter, as many companies don’t explain the dynamics of their business in sufficient detail.

“Companies shouldn’t criticise people for not hearing what they say; they should improve the way they say it and explain their messages logically in language their audience can understand.”

But that does not mean being more verbose.

“Remuneration reports have been getting longer and longer and work needs to be done to cut out the superfluous waffle,” says Matheson.

“It’s easy to get sucked into a conversation down in the weeds, but if companies communicate clearly and succinctly the relationship between short, medium and long-term remuneration, performance and shareholder return, I don’t think most advisers and shareholders will need to read into the detail.”

Broader Thinking

Before getting down to the specifics, Matheson advises directors to think more broadly about what stakeholders would like to see.

“We’ve certainly seen a strong message from the investment community about the need for a clear relationship between remuneration and performance, but boards should also consider the relationship between senior executives’ salaries and those of their employees and peers as well,” he says.

“They should be aware of societal expectations. If they don’t have an investor relations specialist working on their behalf, they should consider employing someone to help them understand the issues and get them in front of the right people.

“And they should start communicating early so there are no surprises when the actual AGM comes around. If they clearly explain the company’s philosophy, the engagement process will much easier and they’re much less likely to find themselves in trouble.”