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 Brandsâ shareholders voted against the boardâs 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.
âExecutives increasing their pay when shareholders are getting nothing is always going to create friction,â 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 executivesâ control. A significant restructure had also been completed a year ahead of schedule.
ââWhat we should have also emphasised was that the delivery of the transformation program ⌠was a critical consideration in the boardâs decision to open the gate for the payment of STIs,ââ he said.
He was right. If one lesson has been learned since the introduction of the âtwo-strikesâ rule two years ago, it is the importance of communication.
âWeâre hearing many chairmen have got the message that they need to talk to the investment community and proxy advisers and that thereâs been a significant increase in that engagement,â says Matheson.
Learning Curve
Guerdon Associates director Michael Robinson MAICD agrees that many directors have been on a rapid learning curve.
âBoards are now more knowledgeable about what is acceptable and what is not, and directors are much more sophisticated in their engagement timing and process,â he says.
âThis shows in the declining level of ânoâ votes and proxy adviser ânoâ 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.â
But is the âtwo-strikesâ rule making companies so cautious that they are all opting for the same, bland model?
âBoards 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,â says Pru Bennett, a director of BlackRockâs corporate governance and responsible investment team for the Asia Pacific Region.
âWe donât vote against remuneration reports with a structure like that, but we will voice concern if we feel itâs not the best model for the company.
âOur 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.â
AMP Capital is on record as wanting to see an RTSR measure in companiesâ performance hurdles, but would not automatically vote against a plan without one.
âWe think it makes good sense for a component of senior executivesâ bonuses to be related to the companyâs 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,â says AMP Capitalâs corporate governance manager Karin Halliday GAICD.
âWe know one size doesnât necessarily fit all.â
Avoiding problems could be as simple as reading the appropriate guidelines.
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âDirectors 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,â says Bennett.
âOur guidelines donât say: âYou have to do it this way.â But they do spell out what we look at from a governance perspective and where we would expect an explanation. In most cases, weâre happy to support a different approach if thereâs a sound rationale.â
Some boards are making an effort to release their directorsâ report at the same time as their full-year results. âThis 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,â says Matheson. âThis could help reduce the move towards conformity.â
Some, such as Telstra, are also testing different ways of reaching their shareholders.
âFor the past two or three years, Telstra has held a series of retail shareholder information meetings around the country ahead of the AGM,â continues Matheson. âIâm told it got almost twice as many people at those than at the AGM itself.â
Where Influence Lies
In shaping their communications, directors need to be very clear about where the real sources of influence lie. âThey should know who is on the companyâs share register, the split between domestic and offshore institutions and whether the offshore component is mainly Asian, American or European,â says Matheson.
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âProxy advisers have different levels of influence within those regions.â
There are also differences in policy between the advisers themselves.
âThey may not appear stark, but they are nuanced enough to result in differing recommendations on how to vote,â says Robinson.
âIn addition, directors should be aware that while a high proportion of institutional investors, and particularly overseas investors, will just follow proxy advisersâ recommendations, many act in accordance with their own guidelines, which can also vary in nuanced ways from those of the proxy advisers.â
AMP Capital subscribes to only one proxy adviser, but Halliday recognises how these differences could create confusion.
âA 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,â she says.
âIt told us later that some wanted to see RTSR, some wanted to see three-year hurdles and some wouldnât vote for anything other than a four-year hurdle.
âIt was quite interesting to hear what some companies have to grapple with, particularly in terms of remuneration.â
However, the companies that have suffered most from remuneration report âstrikesâ 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 boardâs policies.
âThere have been a number of cases where the vote on the remuneration report has been influenced by non-remuneration issues,â says Robinson.
Others are new to the market or among the ASX 300 for the first time.
âThese companies may have been operating in an environment where there isnât quite the same focus on remuneration or their shareholder base might have changed significantly,â says Matheson.
âIf their directors arenât experienced, they can struggle to adjust to what appears to be a new set of rules.â
Overwhelming Interest In Pay
Some commentators are concerned that the âtwo-strikesâ rule is forcing companies to focus on remuneration at the expense of other factors that drive long-term value for shareholders.
âWhile this is true for some investors, Iâve found the increased interest in remuneration has the added bonus of opening the door to more wide-ranging conversations,â says Halliday.
âWhen a chairman comes in to discuss the upcoming resolutions for the AGM, we do talk about remuneration, but we also discuss issues like whatâs 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.
âBut at the same time, analysing the remuneration report helps us build a more complete picture of the companies weâre investing in.
âFor example, if a CEOâs 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 companyâs 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 thatâs calculated.
âSome companies still behave as though that is not shareholdersâ business.â
Thereâs 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.
 âSome directors donât understand that we really do read these documents and are making judgements about the board on public disclosure,â 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.
âThis year, David Jones, Leighton and Newcrest have been criticised for issues other than remuneration and I think that suggests a broader focus,â he says.
âThereâs 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 thereâs a risk that institutional investors will start trying to influence strategy. The final decisions must always remain with management and the board.â
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 companyâs shares.
âSome investors are basing their decisions on a relatively superficial view of a company. Is this the investorâs fault or the companyâs?
âWe believe itâs the latter, as many companies donât explain the dynamics of their business in sufficient detail.
âCompanies shouldnât 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.â
But that does not mean being more verbose.
âRemuneration reports have been getting longer and longer and work needs to be done to cut out the superfluous waffle,â says Matheson.
âItâs 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 donât think most advisers and shareholders will need to read into the detail.â
Broader Thinking
Before getting down to the specifics, Matheson advises directors to think more broadly about what stakeholders would like to see.
âWeâve 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 executivesâ salaries and those of their employees and peers as well,â he says.
âThey should be aware of societal expectations. If they donât 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.
âAnd they should start communicating early so there are no surprises when the actual AGM comes around. If they clearly explain the companyâs philosophy, the engagement process will much easier and theyâre much less likely to find themselves in trouble.â
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