Board Remuneration Oversight

Initial concerns from the Hayne Royal Commission related to Director engagement in the determination of remuneration policy and, in particular, incentives.  Shareholder focus has since turned to Director’s knowledge of performance outcomes leading to the distribution of incentive payments at all levels of the workforce.

Proxy advisers, industry funds and institutional investors have expressed concern about financial metrics and the weighting of those metrics, the use of qualitative performance criteria or, more broadly, non-financial criteria.

Investors appear to be seeking a more comprehensive explanation for incentive payments, particularly of above target payments in relation to the organisation’s absolute and relative performance in the context of the industry sector and the organisation’s plans and performance compared to the prior year.

While it does not appear there is universal agreement in respect of appropriate financial targets, there is general agreement that financial targets are critical.  There is broad acceptance that KPIs which are aligned to an organisation’s transformation and sustainability have increasing relevance, as do the implementation of strategies which support the above and foster growth for the benefit of incremental shareholder returns.

There does not appear to be a warm embrace of APRA’s initial observations that 50% non-financial KPIs should represent the starting point in the design of incentive awards.  There has also been increasing comment that Boards are not supportive of incentive plans being regulated or mandated in some fashion.

While there have been observations that total shareholder return is not always an ideal measure of a company’s performance, earnings are generally accepted providing they represent year-on-year growth/improvement and an appropriate return on assets or invested funds.

There has been some push back on the integration of annual and long-term incentive plans which, while involving a partial deferment of an award, are often a derivative of a balanced scorecard assessment of performance.   This does not currently enjoy wide support, as it almost universally leads to incentives always being paid.

Discussion has also arisen at recent conferences in relation to year-on-year financial improvement as a gateway before any incentive is paid and if financial returns and other quantitative measures are the most appropriate for the determination of an organisation’s health, then other criteria which is qualitative should be embraced as either a gateway or a modifier.

There are clearly some KPIs which will impact variably between industries which are likely to be seen on the boundary of quantitative and qualitative.  This is likely to include risk management and safety.

It is apparent that there is work to be done.  The general consensus is that criteria applied under incentive plans need, in part, to be industry/organisation specific rather than representing a universe of expectation.

An ingredient which has emerged over the last 12 or more months is the level of engagement of Directors in the formulation of incentive strategy, the determination of targets and what constitutes stretch.

The Hayne Royal Commission also raised the question of rewarding revenue outcomes which are achieved in breach of policies or product guarantees or for services not provided.

Indeed, the past 12 months have heightened the expectation of shareholders in relation to Directors’ engagement and understanding of how incentives operate in the organisations over which they have stewardship.