Recent comment from shareholders and their advisers at AGMs reveals a level of disquiet in many organisations in relation to incentive payments, particularly annual incentive payments and supplemental payments for initiatives which many shareholders perceive as being core accountabilities of the KMP and in particular the CEO.
It is also recognised that annual incentives are attached to achieving outcomes which are beneficial to shareholders and extend their core accountabilities and/or relate to the achievement of stretch objectives.
The statement below sets out what we have understood for more than two decades to represent the core accountabilities of a CEO. For the ease of articulation, we have simply described the name of entity as Listco, representing its standing on the ASX.
CEO Core Accountabilities
- Formulate in conjunction with the Board and leadership team Listco’s long-term strategies and plans, including acquisitions, divestment and joint ventures, providing overall guidance in relation to all strategic proposals.
- Provide information and advice to the Board as necessary in keeping members fully informed on all matters affecting Listco’s operations and their impact on the reputation of Listco.
- Ensure that Listco’s investments are delivering acceptable returns and being developed to optimise the business’s sustainability and future profitability.
- Ensure that the Board is fully appraised of all embedded risks in Listco’s balance sheet, supplier and customer engagements and compliance with regulator’s protocols and recommend strategies for adoption in the mitigation of risk and the organisation’s compliance requirements.
- Provide leadership across Listco, both domestically and internationally where appropriate, directing the group’s executive team in the achievement of their operational and financial plans.
- Meet the annual business plan profit, revenue, productivity and growth objectives as agreed to with the Board and direct the energies and resources of Listco to achieve its long-term goals and strategic aspirations.
- Ensure that the development of Listco’s human resources and employee relations policies enhance corporate ethos, ethics and culture articulated by the Board.
We have researched the proportion of CEOs receiving incentives and the quantum of those incentives as a proportion of their fixed remuneration. Across the ASX 100, marginally less than 90% of CEOs received a bonus in the most recent fully reported calendar year. The proportion diminished progressively from 80% in the ASX second 100, through to 54% among companies ranked between 401-500.
There has also been comment and observations made about the level of annual incentive payments which are paid out cash in full or partially deferred as a proportion of KMP fixed remuneration given a company’s improvement in profitability.
While not having the benefit of full disclosure for the 2019 financial year at the time of producing this report, we do have comprehensive information on the performance of the ASX 500 for the financial years ending between January and December 2018. The tables below provide information on profit improvement by ASX Rank between the average and median level of profit improvement between the 2017 and 2018 financial years, as well as by Revenue and Industry Sector:
Among the ASX ranked companies, profitability declined among those ranked in the top 10, ASX 51-100 and ASX 401-500 at the median, though improved in all other categories. On average, profit declined among the ASX 201-300 and ASX 401-500, though improved across all other ranks.
At the median, profit improved in all companies except those with revenues greater than $15 billion and between $500M-1B, whereas on average profit increased across all revenue bands.
At the median, profit declined in the Consumer, Healthcare and Real Estate sectors, whereas on average, profit declined in the Consumer only within the ASX 200 companies.
Among companies ranked 201-500, at the median there were improvements in profitability across in all other sectors. On average, all sectors within the ASX 201-500 also showed improvements in profitability.
Also reported in the table is the average and median level of annual incentive awards as a proportion of fixed remuneration or the Chief Executive Officer or KMP.
Factors influencing the level of incentives
In our view, there are several issues which may be influencing the current levels of incentives. One is Management’s expectations, which might be overlaid by Board members’ prior experience in their executive capacities. Another issue is the lack of forensic examination of what KMPs, particularly the CEO, accomplished during any one financial year which represented superior performance in relation to their core accountabilities.
We observe in the early 2019 FY reporting of the major financial institutions a decline in annual incentive payments for many CEOs and KMPs when compared to prior years. We also acknowledge that this decline is operating in parallel with hundreds of millions or indeed billions being returned to compensate customers for inappropriate corporate behaviour in prior years.
There is likely to be an increased engagement of regulators, particularly APRA and ASIC, in the review of corporate policies and their implementation and the awareness of directors of matters which are critical in relation to both the performance and sustainability of listed entities. It is likely that there will also be an increased focus on the disclosure of the criteria attached to the payment of annual incentives, while in parallel a close monitoring of any movement in fixed remuneration.
In this latter context, we observe a general pause in the percentage increases to fixed remuneration among leading companies over recent years. This has often been accompanied by a parallel adjustment to potential earnings under either annual incentive plans or equity based long term incentive plans. The latter may in part be a reflection of boards adjusting to inappropriate practices of issuing performance or share rights at a discount on advice aligning statutory accounting values for the purpose of equity allocation rather than allocating equity at the prevailing share at the time of awards.
Non-financial performance outcomes
Overlaying these observations, there has clearly been a response to APRA’s initial publication indicating that directors need to focus on significant non financial elements of performance as a foundation for the payment of annual incentives. This has received significant negative feedback from shareholders who are not at ease with a 50/50 financial and non-financial hurdle composite for the payment of those in leading financial institutions. APRA’s proposal has led to submissions from other groups who believe that a key focus should be on frontline sales bonuses with the incorporation of a balanced scorecard construct.
We also observe that some early AGM votes which have led to a strike against the remuneration report have highlighted shareholder concerns about supplemental payments for the achievement of core accountabilities, including the acquisition and divestment of assets and the relative weighting of non financial hurdles. The discussion, in part sponsored by proxy advisers, has also raised the role of financial and non financial measures as modifiers or preconditions before any incentive is paid.
These observations have extended beyond the annual incentive where LTIs have incorporated milestone or strategic measures not always disclosed.
The role of safety in the award of an annual incentive has regularly been raised as a modifier, not an element of organisation performance which should be rewarded as it represents a core element of the KMP’s accountability.
We believe these issues will be remain front and centre over the next triennium as boards and company leadership teams wrestle with new demands in the governance arena, in parallel with pressure from activists which may not in many instances deliver short term returns to shareholders but are focussing on broader societal issues.