Review of 2011 Reporting Season

The 2011 company reporting season  created plenty of headlines as executive remuneration reports were scrutinised by shareholders and the market alike. In this article we  examine  some of the reactions from shareholders and the media and present a perspective on executive remuneration based on our experience with clients over a number of years.

A number of high profile companies have attracted heated media coverage of their annual meetings and remuneration reports during the 2011 reporting season.

Journalists and commentators have been quick to leverage on shareholder concerns about executive remuneration and have raised further questions about the link between pay, shareholder returns and the current year performance. Recent media coverage has focused on two key issues, increases to the level of fixed remuneration and the link or alignment between incentive pay and shareholder returns.

The issue of fixed pay increases always attracts comment, the numbers are high by community standards, but this year the issue of relativity between executive pay and that of the rest of the workforce has attracted most attention. The media coverage has stressed that the growth in executive pay has outstripped the growth in employee wages. The facts support the coverage both here and in the UK.

Analysis by the High Pay Commission in the UK shows that 2010 executive pay in the FTSE 100 rose on average by 49% compared with just 2.7% for the average employee. 

Analysis in the current edition of Egan Associates’ KMP Report shows similar disparity in Australia where movements in CEO pay from 1993 to 2011 have risen seven fold whereas Average Weekly Earnings have only doubled in the same period.(KMP Report)

The alignment of executive incentive levels to shareholder return has also been an issue of real concern. The number of No Votes on remuneration reports has highlighted those concerns that the alignment between the rewards that executives receive from a company and shareholder return is often weak.

This issue is a most complex one and forces boards to consider the challenge of attracting and retaining top talent in an increasingly diverse global economy where shareholder investment has not been restored and profits are either reflecting a declining return on capital or modest year on year growth and where management’s share of profit improvement is increasing.

The graph following illustrates the rate of increase in executive salaries since July 2008.  It also, however, reveals the decline in share values among the ASX 100 over that period.

The period referred to above was also a period in which there was a reasonable degree of churn among the executive population with a number of Boards either replacing the existing team including the CEO from outside or through promotion internally, often secured on lower salaries than their longer serving predecessors.

This period also saw a change on global securities markets where there was a rapid decline in share price and a degree of volatility which changed the paradigm from the late 90s where year on year share prices grew and executives benefited from their participation in incentive plans tied to share price growth, and in many instances they benefited many times their initial expectation arising from buoyant economies, both domestically and internationally.

Post GFC, performance hurdles set for equity based incentives (usually total shareholder return) became far more problematic and many awards granted in 2006, 2007 and 2008 failed to materialise as performance hurdles set pre the GFC were not met.

Arising from these challenges and the challenges generally observed with equity based incentive plans, 2009 saw the commencement of a significant uplift in the value of annual incentives, with a parallel decline in the value of equity based long term incentives subject to three, four and five year performance hurdles.

In parallel with these changes, regulatory changes sponsored by the Government arising out of the Productivity Commission, the Board of Taxation and APRA relating to the taxation treatment of securities issued under long term incentive plans, clawback provisions from annual bonus plans and the noise in the marketplace from shareholders who were expressing concern about the level of remuneration and its misalignment with shareholder returns and their inability to understand Remuneration Reports, further changes have taken place.

Arising from these challenges there has been a general decline in the rate of annual increase in salaries or fixed remuneration, there has been a broad market increase in the level of incentive opportunity under annual incentive plans and a broadening of the base of performance criteria required to achieve bonus payments under these plans.  There has also been an increasing requirement for the most senior corporate executives to have a proportion of their annual incentive award deferred, generally in the form of a share right or a fully paid share, and a diminishing appetite for equity based long term incentives with stringent performance hurdles.

Whereas the trend in the structure of reward in 2005 through 2008 was commencing to foreshadow a third of remuneration as fixed, a third as the annual incentive opportunity and a third as a long term equity opportunity, this pattern is changing, as reflected in the illustration below.

LTI:  Long term equity incentive; STI Cash:  Annual bonus amounts paid in cash;  TFR:  Total fixed remuneration (salary plus superannuation and benefits).

The graph following highlights the rate of growth in total annual remuneration (fixed pay plus annual incentives) of executives among Australia’s top 100 companies commencing with the 1998 financial year.  This graph also reveals the peak of the share market in the 2007 calendar year and the dramatic fall following the global financial crisis and the manner in which executive reward reflected that outcome.      


 In the current market it would be our judgement that negative votes in relation to a small group of listed public companies’ Remuneration Reports are a product of some of these changes and the way in which boards have responded to the challenges imposed by the marketplace.  Boards have a principal accountability to maximise return to shareholders and in so doing ensure they have a management team of appropriate calibre to achieve those objectives and that their leadership group is rewarded in accordance with market practice.

Market practice would be a source of dilemma for many boards, particularly when their market soundings reveal a steady increase in salaries, higher annual incentives being paid, though a circumstance where their share price has not recovered from 2008 levels prior to the GFC, profits are under stress, and assets have been revalue as a result of the GFC. Others are directly affected by global volatility particularly where they have operations in  Europe or North America or where their export activities are impacted negatively by Australia’s terms of trade, all the above increasing demands on their leadership team.

Shareholders would have a perspective whereby they observe increasing levels of remuneration paid to executives in a three year period where the value of their shareholdings has declined and not recovered from the GFC, where dividends are static or below pre-GFC dividends, and yet in these circumstances they observe that the ‘management class’ are receiving rewards endorsed by boards of directors which continue to increase.

Boards on the other hand are faced with the dilemma of retaining talent in a market where talent is a scarce resource, meeting a variety of competitive influences which will be both industry and occupation related, with pressures coming from within Australia and, for major international firms, external to Australia, where governance and other standards are quite different.

Equally, there appears to have been little or no consideration of the relative appreciation of Australian executives’ remuneration as a result of the considerable appreciation in the Australian dollar, whereas a decade ago there was heightened focus upon many organisations with a growing international reach on the lack of competitiveness of Australian reward levels.

It would be our judgement that boards and shareholders will not find their perspectives aligned until remuneration becomes simpler in its form, communication more open and transparent and the rate of change in remuneration better aligned with shareholder welfare, with an increasing number of companies requiring a growing proportion of incentive reward to be held in equity by senior staff to ensure alignment with shareholders.

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