Remuneration Governance – Boards at Risk

Recently two major trends have emerged in remuneration consulting that are causing Egan Associates significant concern.

1. A decline in the number of companies seeking remuneration recommendations

Over the last few years, we have noticed that fewer companies who come to us for advice are asking for recommendations. An increasing number of remuneration committees are limiting their requests to benchmarking and are then taking their own advice as to what is a reasonable level of remuneration given their results.

This is not isolated to Egan Associates, as is depicted starkly in data from annual reports, which show that the number of top Australian companies disclosing the fees they paid to remuneration consultants (and therefore receiving remuneration recommendations) has declined dramatically between 2012 and 2015. (In 2011, legislation was introduced that required companies to disclose the fees they paid that were connected to remuneration recommendations.)

The proportion of organisations disclosing the level of fees provided to a remuneration consultant has reduced from 40% in 2012 to 20% in 2015 as can be seen the figure below.

Remuneration Recommendations top Australian Companies

In general, larger companies are less likely to receive remuneration recommendations than smaller companies, a trend that has become stronger from 2012 to 2015. This is despite the fact that top 100 companies are 10% more likely to disclose the use of a remuneration consultant than top 300 companies.

As can be seen in the figure below, while the proportion of top 100 companies disclosing a consultant remained similar in 2012 and 2015, the proportion of companies disclosing a consultant that also disclose fees fell markedly. The fall is also present in the top 300, but is not as pronounced.

companies-disclosing-a-consultant

Not all 2016 annual reports have been released, so it is not possible to conduct a similar analysis for 2016, but Egan Associates strongly doubts that the number of companies seeking remuneration recommendations and disclosing fees for those professional services has increased year on year.

Accounting firms that provide remuneration advice to companies are less likely to provide remuneration recommendations than standalone remuneration consultants, even if they are listed as the sole remuneration advisor. 

The figure below displays that the proportion of advice that contains remuneration recommendations has fallen between 2012 and 2015 for both standalone remuneration advisors and accounting firms. However, for accounting firms it has fallen further, from an already low base. If an accounting firm is disclosed providing remuneration advice to a top 100 company, there is less than a 10% chance they will be providing a remuneration recommendation.

Remuneration recommendations from remuneration consultants and accounting firms

About a third of the top 100 companies and a quarter of top 300 companies disclosed an accounting firm as their sole remuneration advisor in 2015 (One third for both groups in 2012). Are accounting firms reluctant to provide remuneration recommendations to clients?

Why are fewer companies receiving remuneration recommendations?

Egan Associates identifies several possible reasons for this trend.

  • Following the introduction of the legislation, Boards may be trying to avoid scrutiny of remuneration advisory costs, either by the media or by investors.
  • Boards may also be trying to avoid the situation whereby investors ask to see the remuneration advisor’s recommendation. If the Board has followed the recommendation and investors consider the recommendation to be inappropriate, the Board will be criticised for doing so. If the Board did not follow the recommendation and investors decide it was appropriate, the Board will similarly be criticised.
  • Boards may be following proxy advisor requests to independently consider the appropriateness of executive remuneration even if they receive expert advice (benchmark data is not expert advice). We note that the receipt of a remuneration recommendation does not remove the responsibility of the Board to understand and agree with the reasons the advisor has used to reach their conclusions.
  • Boards may not be comfortable with informing a consultant of the companies’ challenges (which will affect remuneration decisions) because they are highly sensitive and confidential.
  • Boards may be concerned about finding a sufficiently experienced consultant. To have the breadth of experience to understand the nuances across industries, the implication of strategies and their global impacts as well as the task of retaining or attracting global talent is beyond the experience of many consultants.
  • Some advisors may not be confident enough in their expertise to be able to provide a remuneration recommendation and accept the risks that come with such a recommendation. They may believe they are vulnerable if they provide a recommendation which leads to a strike.

Why this trend is of concern to Egan Associates

Without remuneration recommendations, Boards are forced to take their own advice. In many cases this will lead to acceptable results. However, there are risks from selecting an inappropriate remuneration structure. A Board’s accountability is increasingly expected to extend beyond the C-Suite and be forensic.

Consider the recent Wells Fargo case where employees opened fake accounts under customers’ names to meet incentive targets. If the incentive targets had been differently designed, they might have deterred the fraud from occurring. If a Board has not received remuneration recommendations and such an issue arises, the Board will be solely responsible. This will especially be the case if the Board adopts an innovative remuneration program that does not follow general market practice and is not well explained.

If Boards take their own advice there is also the risk of conflicts of interest where management try to influence the Board’s decisions, suggesting they change hurdles, adopt accounting standards that would make performance measures easier to meet or increase salaries based on ad hoc pay comparisons with top quartile peers.

In addition, remuneration data is best understood when placed into context, an issue we have previously written about in detail.  Benchmark statistics are based on assumptions which will depend on the creator of the dataset – it takes years of experience to understand and compare data. Issues include inclusions and exclusions, movement in index constituents, calculation methodologies for equity payments, ambiguity of position titles, but there are many more.

It takes even more experience to know which data to ask for. Should a Board benchmark its executives using Revenues? Assets? Market Capitalisation? Or a combination of the above? Which sectors, industries or subindustry sectors should be considered? Should the Board consider international peers? Are the same metrics appropriate for all roles?

If a Board receives a remuneration recommendation, it can be sure that an informed position will have been taken on these matters. In addition, any recommendation will have been made considering the surrounding economic and regulatory environment. To determine the correct total reward for an executive, the health of the economy (international, national and local), the relevant sector and the company will be considered as well as the individual’s and company’s performance as can be seen in the hierarchy below.

Context for remuneration reviews2. A trend towards using accounting or legal advisors for all remuneration work rather than hiring standalone remuneration specialists

In our work, we have anecdotally observed an increase in the use of either an accounting or a legal firm to provide remuneration advice, without seeking advice from a specialist remuneration organisation. Although accounting and legal firms do employ remuneration specialists, they are also likely to have a broader engagement with the client that will dominate the relationship.

The data from annual reports does not back up our anecdotal observation – if anything it points to a movement in the opposite direction, with less work being directed to accounting and legal firms and on increasing proportion of advice being conducted by specialist remuneration consultants. However, given the trend of poor disclosure of remuneration advice revealed above, especially for accounting firms, Egan Associates would ask whether the data is reflecting the true state of affairs in this case.

Certainly, the proportion of organisations disclosing the receipt of remuneration advice from more than one external expert has reduced from 2012 to 2015 as disclosed in the figure below.

Proportion of companies seeking advice from more than one consultant

Why are fewer companies disclosing the receipt of remuneration advice from multiple advisors?

Egan Associates offers three possible reasons for this trend.

  • Organisations may still be receiving remuneration advice from multiple advisors, but only disclosing some of them.
  • Boards may be trying to keep costs down in the uncertain economic environment.
  • Boards may not understand the different roles that remuneration specialists, accounting firms and legal advisors undertake during the design and review of remuneration plans.

Why this trend is of concern to Egan Associates

The delivery of recommendations increasingly requires the input from a number of advisors with specialist knowledge as well as a thorough understanding of market dynamics and the supply and demand of talent.

For example, when companies are preparing for an IPO, collaborative input of several advisors is required and is, from our experience, highly beneficial. Transitioning reward arrangements from an unlisted environment to an ASX/NZX traded entity while correctly handling disclosures is a key collaborative task.

The remuneration advisor brings a comprehensive understanding of the market and the way remuneration is structured, which will vary within industries and among organisations of different enterprise values.

The tax advisor will assist the company in a far broader context but can provide authoritative advice on the nuances associated with transferring from an unlisted environment, on the management of securities/equities held by KMP at that time, as well as on participation in equity programs requiring shareholder approval.

The company’s legal advisor will have a primary accountability for prospectus preparation and disclosures and will provide a legal sign-off in relation to the matters referred to above. They will have primary carriage of legal documentation including employment agreements, post employment restraints and the sign-off of rules for equity-based incentives.

Often after an IPO a Board may believe that only one of the above professional advisors has ongoing relevance in remuneration matters. Egan Associates does not believe this is the case. Each advisor has an important role to play, which if neglected can lead to sub-optimal outcomes down the track.

The remuneration consultant will ensure the reasonableness of remuneration. The accounting firm or auditor will confirm the effect of remuneration on the organisation’s reporting and taxation.  The legal advisor will ensure compliance with regulations. Without all three, Boards cannot be certain remuneration is reasonable, correctly reported and compliant.

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