High executive remuneration is blamed at least in part on remuneration consultants – the universal belief is that remuneration consultants will always recommend an increase in pay because if they don’t, they won’t be reappointed to advise the company in the following year.
In Australia, the Corporations Act was amended in 2011 to prevent such behaviour, mandating that before a company enters into a remuneration consultancy contract the proposed consultant must be approved by the Directors of the company or the members of the remuneration committee. It also prohibits remuneration consultants from providing remuneration recommendations to executive Directors, requires the fees received for recommendations to be disclosed, and requires the provision of a statement that advice was made “free from undue influence”.
The idea behind the amendment was to ensure that management were not able to control the consulting relationship that will be instrumental in setting their own pay – enabling remuneration consultants to provide independent advice.
“It should be the case that remuneration consultants are able to confidently go to a company and suggest that the remuneration is too high. This ought to happen in more than a trivial number of cases, and I doubt that it presently happens in many cases,” Labor MP Dr Andrew Leigh said in 2011 before the Bill was passed.
As an independent consultant, Egan Associates does not shy away from informing Boards that executive pay is above market where this is the case. Yet, we would be surprised if the same could be said for all advisers.
A potential contributor to this lapse is that the work of consultants is not always covered by the legislation. The issue is one of definition, namely, the definition of a remuneration recommendation.
According to the legislation, a remuneration recommendation is:
(a) a recommendation about either or both of the following:
(i) how much the remuneration should be;
(ii) what elements the remuneration should have;
for one or more members of the key management personnel for a company; or
(b) a recommendation or advice about a matter or of a kind prescribed by the regulations.
A remuneration recommendation is NOT (even if it would otherwise be covered by the above):
(a) advice about the operation of the law (including tax law);
(b) advice about the operation of accounting principles (for example, about how options should be valued);
(c) advice about the operation of actuarial principles and practice;
(d) the provision of facts;
(e) the provision of information of a general nature relevant to all employees of the company;
(f) a recommendation, or advice or information, of a kind prescribed by the regulations.
Given the rules above, it is not difficult for a consultant to provide remuneration guidance to a Board, or even executive Directors, that would not be classified as a remuneration recommendation. Indeed, in the years since the introduction of the legislation, the number of companies disclosing a remuneration recommendation has reduced dramatically.
An example of advice that does not constitute a recommendation would be where a remuneration consultant provides benchmarking data to an executive.
This would not be counted as a remuneration recommendation, as it is the provision of facts. Yet, the advisor may have only received the instruction to provide remuneration data for “companies similar to X”, leaving the definition of “similar” up to the consultant.
We have often written about how benchmarking can be conducted in many ways, each of which will return a vastly different result. In deciding which companies to include as comparators, a consultant must exercise their judgement and therefore provide an implicit remuneration recommendation (although the legislation would not judge it so).
If conflicts of interest exist, it would not be difficult for the consultant to return “facts” to an executive that reflect what the executive wants, and do not reflect reality.
Even if the letter of the law is followed and remuneration consultants present a remuneration recommendation to the Board, management can still exert influence on a consultant by using the Board as a conduit to transfer their expectations. A poorly informed Board may even become an advocate for an executive’s demands.
If a remuneration consultant is being serious about their role as an independent advisor on remuneration, they will be mindful of the expectations of involved parties.
Management’s expectations might include that remuneration reflects:
- Their personal capital/expertise
- Expected tenure
- Prospect of a failure/sector volatility
- A fair share in the company’s success given management’s contribution to value creation
The Board’s expectations and policy settings might include that:
- Remuneration policy enables the company to attract and retain appropriate talent
- Remuneration constructs encourage the best performance possible under the company’s current circumstances
- Remuneration structure discourages risk taking and/or unethical behaviour
- Remuneration does not exceed community expectations
Boards will also be representing shareholder expectations, which might include that:
- Remuneration be competitive but not excessive with regards to industry and regional factors
- Payment of equity incentives be of an appropriate term and predominately based on performance
- Conditions of equity grants should remain stable
Yet even as the remuneration consultant considers these viewpoints, they will remember the spirit of the 2011 legislation.
“The primary responsibility for remuneration arrangements rests with company Boards,” the explanatory memorandum states.
This is not to constrain the ability of remuneration consultants to provide advice in the form of data to management, but as a reminder that executive expectations should always be seen through the lens of the Board’s, and hence shareholders’, expectations.