Company Remuneration Reviews, which will be progressively undertaken over the balance of the 2020 calendar year, will be influenced by the factors below, but equally framed in the context of variable sector prosperity and forecast growth/decline.
Sector forecasts in a variable-speed economy will influence decisions at a micro level as companies endeavour to manage their capacity to pay, their future prospects and the criticality of retaining their experienced and capable workforce.
In exercising a broadly-based judgement it would be appropriate for employers to apply a number of separate lenses as they consider any annual adjustment for staff and the broader management group across their organisation. The relevant factors continue to include the following.
The Business Setting
- economic setting and workforce planning;
- business’ plans and challenges;
- legislative/government policy settings;
- criticality of retention, recruitment and succession planning;
- comparative market positioning of key staff’s current fixed remuneration;
- organisation performance and near-term growth/profitability expectations.
Criticality of Retention, Recruitment, Succession Planning
Market supply and demand:
- ease or difficulty in attracting/retaining qualified staff;
- existing staff turnover/layoffs.
Internal/external pay anomalies:
- new hires,
- re-alignment of role accountabilities and capability requirements.
The above issues clearly represent reference points as organisations address the key elements in senior staff reward and where to place the emphasis in retaining talent and being able to attract talent for their operations in the year ahead.
At the time of preparing the 2020 foundation for annual reviews, enterprises of varying scale with different profiles, be they regional, national, international or global, will need to address a number of critical employment issues and workplace challenges.
These include those arising from COVID-19; the impact of environmental challenges including drought, bushfires, floods, and other natural disasters; workplace challenges including the ability to secure employees with contemporary skills and capabilities to meet the changing demands with the increasing growth of artificial intelligence, technology including robotics; global competition and the imposition of new global trade negotiations and currency instability.
Currently, while a significant proportion of the foreshadowed government support for those affected by drought, floods and bushfires have not been comprehensively addressed, the impact of COVID-19 has been dramatic and has led to recent announcements by the Federal Government that it will defer its budget review until the fourth quarter of the current calendar year while supporting business and the underemployed workforce.
In addition to their support for employers and employees and the health sector more broadly arising from the COVID-19 pandemic, governments remain under pressure to attend to the environmental issues mentioned above and to apply similar pressure to insurers to remain proactive and fully engaged in supporting the affected communities who have suffered significant loss.
Reduced Pay Levels
With the significant and dramatic impact of COVID-19 on a number of industries, we have observed that several companies have taken the initiative of reducing prevailing levels of management pay in recognition of the significant cost constraints impacting their industry.
Many employees have been stood down, though have had the benefit under negotiation of receiving full pay during the initial period of uncertainty by drawing on unused annual leave and other leave benefits including long service leave.
Sharing the Pain
What pay forfeiture are Federal, State and Local government employees facing as private sector employees lose their jobs or accept pay cuts? Should social distancing also be mandatory in the public sector? We note that public servants have recently been allowed to work from home. Should all government employees be “protected species” or only those in hospitals and the healthcare sector?
The rate of policy variation and relief and stimulus packages across the nation at State and Federal government levels clearly reveals that current challenges will be progressively addressed as the virus either extends or plateaus and impacts on different urban and rural communities.
We note that New Zealand’s Prime Minister and the country’s Ministers and Chief Executives within the public service will take a 20% pay cut in response to the pandemic and the impact it is having on global economies. The pay cut will be for six months.
Since the ASX peaked on 20 February 2020, a number of market sectors have experienced significant declines in their market value, including telecommunications, resources and materials, real estate and property trusts, consumer discretionary including tourism, leisure and retail, financials, information technology and industrials whereas more defensive stocks have performed better, including consumer staples, healthcare, utilities, and energy.
Integrity of Reward
In the current governance setting, though independent of COVID-19 and emerging primarily from the Hayne Royal Commission we have observed a number of initiatives taken by leading organisations in addressing criticism of reward practices in the financial services sector.
APRA has established guidelines in relation to the integrity of reward at all levels across the sector, and ASIC have reviewed the integrity, governance and risk protocols of many corporate entities whose practices fell short of community expectations.
Other challenges which are also being managed in the current environment and which have become publicly disclosed in respect of a number of entrepreneurial enterprises and major corporations is the underpayment of staff and making good on those arrangements.
In addressing 2020 mid-year reviews for their organisation’s leadership and the two to three tiers below, Boards may well be placed in a situation of having to consider current levels of fixed remuneration in light of dramatically changed revenues and enterprise value as reflected by declining share prices and profitability. These circumstances will have an impact on an organisation’s capacity to pay bonuses and settle awards associated with the provision of equity-based long-term incentives at prices which represent a substantial discount to the average price paid by shareholders.
Annual Incentive Plans
Where annual incentives which were paid in respect of the 2019 financial year for companies which may have ended in the first quarter, 30 June, at the end of the third quarter (such as a number of the banks) or at the end of the calendar year, they would have been awarded an annual incentive on the basis of their accomplishments and in many instances for the KMP a proportion would have been deferred.
Of those plans, probably half are deferring cash and half are deferring equity.
Where they are deferring cash, there will be no loss of entitlement or benefit albeit they might be deferred in two tranches – a proportion after 12 months and a proportion after 24 months.
Where they are deferred in equity – they might have been deferred when a share was $3.00 and when they vest the share price might be $2.00 – hence there will be alignment with the circumstances which shareholders face, though represent a 33% loss in the award value.
Where the deferral hasn’t resulted in the acquisition of a share or a right to a share, the deferred cash entitlement will equal the STI award value.
Should an incentive be paid in respect of the 2020 financial year with similar deferral protocols, then it is highly probable for those incentives arising in financial years ending up to 30 June that equity would be issued at a 20% to 30% discount to that which prevailed at the commencement of the 2020 financial year.
It’s also highly probable given the impact of COVID-19 that revenue and profit objectives will not have been met, though Boards may form the view that senior management in their organisation have achieved a significant outcome relative to their industry peers despite pressures, have kept their workforce employed, have adopted innovative programs and solutions, brought forward new products which have enabled them to prosper but not achieve what was set as financial objectives in May / June 2019.
This would represent a significant challenge for many companies and many Boards and also lead to a circumstance where it is highly probable that incentives for KMPs will either not be paid or be substantially below target or expectations.
With KMPs it is not unusual for a cash-based target annual incentive to have a value equivalent to between 25% and 60% of their annual salary. If that is not paid it leads to an outcome where earnings of senior management will be reduced.
Operating in parallel with this circumstance will be the fact that many organisations will have asked management to take a 20% or greater cut in their fixed remuneration.
At the time of preparing the policy settings for the 2021 financial year, Boards will also be addressing what performance conditions would justify incentives in the third quarter of the 2021 calendar year when the results of the next financial year are disclosed.
Will annual incentives be paid for achieving improvement on the 2020 financial year result? Or will parameters be established on the basis of expected performance over the triennium 2020 through to 2022?
In parallel will be questions in relation to the KPIs which might be established for a 2021 financial year and their relative weightings:
- Should new KPIs include recovery from the impact of the pandemic?
- Is it probable that weighting of recovery KPIs might double the earlier weighting attributable to strategic and operational objectives in the current financial year?
- Should KPIs for annual incentive programs be customised to the time or retain the structure that has been agreed and approved over many prior years?
- Will the pandemic lead to a re-weighting of traditional KPIs?
- Among organisations where 80% or more of any annual incentive has been predicated on financial results and a modest proportion to individual KPIs, should those weightings be modified in circumstances reflective of the likely challenges organisations will face in a global economy and a national economy in the 2021 financial year?
- In listed public companies and in privately held companies where owners will not receive rewards that they might have anticipated, should Boards also consider circumstances facing shareholders when determining appropriate total rewards for management?
Long-Term Incentive Plans
How will organisations choose to allocate entitlements under long-term incentive plans for the executive team? Will they issue performance rights or options on the basis of prevailing share prices at the time of the results’ announcement for the 2020 financial year?
Will they adjust the incentive value in an environment where shares are at a 20% discount to what was achieved in February 2020?
Will they use relative total shareholder return as a modifier and universally embrace earnings as the principal performance criteria?
How will they manage rewarding their leadership team three years hence following a period of dramatic change and foreshadowed uncertainty, ensuring that reward levels will retain and attract appropriate talent and reward highly effective performance?
This is a challenge not faced by the majority of today’s ASX 300 Board members, though it is real in the minds of shareholders who, during periods of significant share price growth and prosperity and particularly international development, while not necessarily supportive of the rapid escalation in fixed remuneration, have been supportive of total shareholder returns being the foundation for rewarding executives.
Reward Post COVID-19
New questions which will arise in the period immediately ahead will constitute what represents appropriate reward in the context of significantly diminished enterprise values, what represents fair reward to executives under long-term incentive plans where their companies may, in relative terms, have outperformed others in an industry index or in the ASX 200 or small cap market, but led to a circumstance where shareholders have suffered a 20% or 30% loss in the value of their investment.
What, if any, considerations are Boards giving to the setting of fixed remuneration levels when replacing CEOs and other KMP in circumstances where the company’s enterprise value is substantially reduced from that upon which reward levels were established in prior years?
In this context, has enterprise value diminished as a measure of work value and the challenges faced by leadership groups in managing through the triennium ahead?
These are not questions which will be front of mind in the Fair Work Commission and submissions made to the Commission, but are very important questions to be addressed by Directors and their advisors.