After noting the release of the Australian Shareholders’ Association discussion paper in our last newsletter, we have now formulated our thoughts on the points raised.
While we do not favour prescriptive rules, it is our judgement that a number of the observations of the ASA are worthy of discussion and consideration. The ASA’s primary focus is retail investors and the comments in the paper are heavily directed towards those investors, who are significant in number but often not in influence, particularly among ASX 100 companies.
The ASA’s report is divided into three sections: one addressing the broad issue of the role, commitment and tenure of Non-Executive Directors; another communicating and engaging with retail shareholders; and the final section commenting on executive remuneration. As our primary focus is in the field of remuneration our comments in relation to the former two sections provide a general observation of the tone and content of these sections.
Role, Commitment and Tenure of Non-Executive Directors
We do not accept the prescriptive observation that Non-Executive Directors should serve on a maximum of five separate and unrelated public company boards as a useful guideline, as we observe significant differences in our own dealings with Boards in relation to director capacity, time availability and expertise. In the same way we do not agree with prescriptions on Director tenure.
We acknowledge the critical nature of the work of Directors and observe the ASA’s observations in relation to a number of policy issues such as Director and Chair appointment, skills, duties, workload, performance and independence, as well as the importance of Board work.
We do not accept ASA’s proposal that chairmanship but not membership of a Board committee should prima facie attract additional payments on top of the general Board fee, again for reasons of capacity and expertise. We believe a Board is in the best position to determine the most appropriate approach to structuring Directors’ fees and should customise the outcome of their deliberations having regard to circumstance and not be subject to universal rules. We acknowledge, however, the enhanced duty of care that is likely to be imposed on the Chair.
Equally, we do not support a prescriptive view in relation to the multiple of a Chairman’s fee compared to that of Non-Executive Directors. We accept that the Board in determining the allocation of fees approved by shareholders is in the best position to form a judgement as to capacity and commitment in relation to the allocation of fees.
We accept the observations in relation to the disclosure of remuneration advisers – that remuneration advisors and fees be disclosed, including disclosure when / if the audit firm is used to advise on executive or Board remuneration and when an advisor recommended an increase in Director fees in the coming year. We recommend additional disclosure addressing any actual or perceived conflicts of interest involving the use of remuneration advisers and also disclosure confirming (or otherwise) the implementation of any such recommendations.
The ASA also recommended that Directors receive at least 20% of their annual fee in shares up until five years of service (when one year’s worth of cash fees is held in company shares). While we believe that in certain settings Directors owning equity in the company may have merit, we do not support a universal prescriptive rule.
Communicating and engaging with retail shareholders
We are supportive of open, comprehensive and transparent communications. We are not supportive of Directors’ Reports or Remuneration Reports which endeavour to obfuscate corporate information through omission or complexity and believe that these reports should be prepared in a manner where retail shareholders understand a company’s policies and practices while at the same time meet compliance requirements established under law.
We support in broad terms the intent of the ASA’s observations in relation to long term alignment with shareholders, the fixed remuneration proportion of total reward for CEOs and KMPs and termination benefits. Again we hold the view that Boards are in the best position to know how to best manage the retention and attraction of talent to meet their longer term strategy and sustainability, as well as their near term profitability and performance.
We note the ASA’s preference for remuneration to be made up of only two components – fixed remuneration and long term incentives (LTIs) and its desire for the latter to have a minimum performance assessment period of four years.
An increasing number of companies which adopt the more traditional structure of fixed remuneration, short term incentive (STI) and LTI require executives to defer a proportion of their STI into equity for a period up to three years, though more commonly one or two years. In these cases, STIs behave like LTIs by aligning the executives’ interests with the long term interests of shareholders. Deferring a component of STI is also perceived as an increasingly effective means of aligning executives’ interests with the interests of the firm as a whole (including debtholders). We are broadly supportive of the ASA’s proposal for a two-year deferral of a significant portion of executives’ STI, albeit with some proportional release of the deferral after twelve months.
Currently much of the market operates on a three-year LTI cycle, being the period of time the Board can confidently make a reliable assessment of longer-term outcomes. Again, the Board is in the best position to understand the company’s circumstance and industry outlook – where the Board believes a longer performance period would better manage and incentivise desired performance, it should introduce it.
In this context we also note and endorse the ASA’s acceptance of annual retesting of LTI performance criteria if used to enable the extension of vesting periods up to six years, encouraging market outperformance over a longer period.
We also support the ASA’s preference for relative total shareholder return as a principal measure of long term effectiveness where there is no more suitable or more tailored hurdle and share its concerns in relation to securities vesting where shareholders have not benefitted, a concern we raised in our July newsletter.
We note the ASA’s view that 30% of equity vest when the relative total shareholder return is at the 50.1th percentile and 100% at the 85th percentile. We agree that with larger companies predominantly using share rights or performance shares rather than options, Boards should give consideration to more modest vesting at the 50th percentile, though do not endorse full vesting at the 85th percentile as a standard, as we believe such an initiative might lead to excessive risk taking on the behalf of executives to achieve top performance. We also note and broadly endorse the relative TSR benchmarking against relevant industry sectors or enterprises with broadly common attributes rather than broad market indices, so long as the relevant comparator group of companies is transparently communicated to shareholders and uniformly adopted for each relevant LTI grant.
We also observe the ASA’s preference for having more than one LTI performance measure and accept its general observations on the suitability of various measures including earnings per share, return on assets and return on capital employed, but disagree with the ASA’s general disfavour of return on equity as we believe that in some settings it can be relevant at certain stages in a company’s development and capital raising. We believe that return on equity provides a good internal measure of the company’s performance against its cost of capital objectives.
We endorse the view that where there is no STI, other factors impacting on a company’s performance and its sustainability have a place in LTI schemes, such as the achievement of certain milestones or meeting broadly indexed standards in relation to corporate reputation, customer satisfaction, safety and environment KPIs. We concur with the ASA’s preference that such non-financial metrics be limited to a small minority of the award.
We note and broadly support the preference for pro-rata vesting of incentive awards in the event of takeovers rather than full vesting, though again believe it is important that boards retain discretion as the circumstances surrounding acquisitions, divestments and takeovers are highly varied and the board is in the best position to make a judgement which represents a fair and balanced outcome for all stakeholders including participants of long term incentive plans.
We support the general view that market value is preferable to discounted values for the purpose of allocation of securities now that share rights and performance rights are granted more often than options. The valuation of securities for remuneration intent purposes should not account for the risks of not achieving the relevant performance targets.
We note the ASA’s policy in relation to two strikes and support its position of communicating with organisations and seeking modification to pay practices in substitution for triggering a board spill.