Egan Associates is observing a more disciplined commitment by Boards in ensuring incentive payments are governed by financial, operational and strategic performance.
Egan Associates explored the short term incentive payments for CEOs and the next three top paid executives among Australia’s top 100 companies for the three years from 2011 to 2013. These payments were compared to companies’ operating profit performance over the same time period.
While profit improvement is only one measure of the C-suite’s accomplishments during any single year, investors are increasingly scrutinising other performance criteria that may lead to an incentive payment despite minimal alignment with shareholder returns.
The following figure shows the proportion of companies that recorded an improvement in operating profit over the three-year period, where the sample is the top 100 companies ranked by market capitalisation as of 30 June 2013.
Figure 1: Proportion of Companies achieving Operating Profit Improvement within the ASX 100
Figure 2 and Figure 3 reveal median and average STI payments as a percentage of fixed remuneration in both performance settings for CEOs and top 3 executives (which excludes the CEO).
Figure 2: Ratio of STI Awards to Fixed Remuneration for CEOs within the ASX 100
Figure 3: Ratio of STI Awards to Fixed Remuneration for the top three executives within the ASX 100
2011 was the year the two strikes rule was introduced. It is also worth noting that a number of executives of ASX 100 companies voluntarily waived payments of their bonus in 2012 despite being entitled to one.
The effect of outliers is evident in the average values for all three years. It is clear that despite a lack of performance improvement, selected companies provided significant payments to their CEOs and executives. This situation appears to have been partly remedied by 2013.
Considering the median, in 2011 there was little difference to the STI payments of CEOs between companies that had improved their operating profits and companies had not. Both sets of CEOs received payments at around 70% fixed remuneration. For the top three executives excluding the CEO, those serving with companies that did not improve their operating profit result actually achieved higher awards than those serving with companies that did improve their operating profit.
This situation improved in the 2012 and 2013 years, with a clear benefit arising for executives and CEOs who served with companies that had improved their operating profit. This was despite a higher proportion of organisations recording declines in operating profit. CEOs of companies with improved performance received approximately 75% of fixed remuneration while CEOs of companies with declining performance received 40% to 50%. Top three executives received payments of around 50% fixed remuneration for improved performance and 30% to 40% for declining performance.
The change in STI award as a percentage of fixed remuneration also shows there is a pronounced benefit for CEOs and executives who serve on companies where operating profit has improved, as can be seen in Figures 4 and 5.
Figure 4: Change in STI Award 2012 to 2013 as a percentage of Fixed Remuneration for CEOs within the ASX 100
Figure 5: Change in STI Award 2012 to 2013 as a percentage of Fixed Remuneration for top three executives within the ASX 100
It is also worth noting that the proportion of companies that do not pay an STI has risen from 2011 to 2013, although it is still low.
Figure 6: Proportion of Companies where the CEO received an STI Award
Figure 7: Proportion of Companies where the top 3 executives received an STI Award
Disregarding whether companies have experienced an increase or a decline in operating profit, the value of STI awards has increased as a proportion of fixed remuneration from 2011 to 2013. The median ratio of operating profit to short term incentive has however remained constant over the three years as can be seen in Figure 8, signifying that incentives have risen with profit.
Figure 8: Median Ratio of STI Awards to Operating Profit for the ASX 100
Overall the data reflects Egan Associates’ observations that while bonuses are occasionally paid in the C-suite when companies’ performance has reflected a loss or a decline in profit year-on-year, increasingly incentive awards are reflecting actual performance, either through incentive design or due to the application of discretion.
Boards are acknowledging that levels of fixed remuneration in Australia are now highly competitive by international standards so annual incentives need to reflect improved company performance, not an annuity reflecting a proportion of absolute profit or share price increase.
Egan Associates acknowledges that budgets following a spectacular result can reflect a Board’s expectation that the prior year’s performance will not be achieved in the following year. Equally, business divestment can result in declining profit and revenue while not being detrimental to shareholder return.
There are also cases where Board discretion is used to respond to achievements of the leadership team during periods of unexpected adversity or corporate restructures, transformation initiatives and significant investment where progression is well regarded by the Board and is comprehensively explained to shareholders.
While many companies’ explanations of the foundation of performance payments still fall short of ‘best in class’, an increasing number of organisations are providing more detail of reward outcomes either in the Remuneration Report or an introduction to the Remuneration Report by way of a letter from the Chair of the Remuneration Committee.