Reward in the Financial Sector

Is it time for a new paradigm?   

Board Remuneration Committees of major companies, of which financial services represent a significant proportion, generally seek information and occasionally advice from consulting organisations in positioning their remuneration strategy.

This advice often includes setting annual salaries and benefits, establishing policies in relation to both annual and long-term incentives and determining appropriate performance conditions for payments under those programs.

The approach adopted by the majority of consulting organisations would be described as undertaking a benchmark review and, in that context, reviewing the practices and levels of reward among organisations of comparable scale.  Such a review would typically consider financial metrics in a similar industry and comparable customers and suppliers where appropriate.

A further overlay will often relate to the international spread of the organisation’s activities which can require investigation into reward practices in many jurisdictions outside Australia.

In financial services, including banking and insurance companies and wealth managers, a key focus of Boards is the practices of their peers.  This, in part, is predicated on the desire to retain a level of talent to meet the organisation’s operational demands, ensure its sustainability and develop its business base, either in terms of product diversity, geographic diversity or both.

Many would believe that this process has led to a leap-frogging in reward levels as organisations strive to remain competitive.  Competition will be influenced by the peers they consider as relevant, the global spread of the organisation and the sources drawn upon by the Board in populating the first two layers of management in their organisation.

A number of witnesses in the Banking Royal Commission revealed that things can and have gone wrong and occasionally inappropriate practices have arisen through dishonesty.  On other occasions failures have arisen because of neglect, carelessness or just sheer coincidence.  The “root cause” for inappropriate conduct has been described in Justice Hayne’s interim and final reports as often being sponsored by greed through “the pursuit of short-term profit at the expense of basic standards of honesty”.

Many of the observations in the Royal Commission’s two reports reflect on a principal source of inappropriate judgement and reward outcomes being underpinned by poor culture.

Some evidence also revealed that Boards, and their Remuneration Committees in particular, relied too heavily on reports from management and assurances of the organisation’s compliance with policies including codes of conduct as well as fulsome and transparent communication with the organisation’s customers.

It can equally be observed over recent years that although a number of leading financial institutions primarily sought information from remuneration consultants, they did not seek advice or recommendations.  Implicit in these observations is that the accountability for interpreting information could well have rested with management with the Board authorising recommendations sourced from management rather than independent advisors.

Partly implicit in these outcomes could well be the independence of the advisor.  Notwithstanding the above and the acknowledgement of many leading financial institutions and their Boards that they need a more detailed appreciation of reward practices throughout the entire organisation, Directors need to reflect upon the appropriateness of prevailing reward in the context of what constitutes “reasonable remuneration” as set out in the Corporations Act 2001.

It is essentially the responsibility of the Board Remuneration Committee to ensure the entire Board is fully informed and well-advised in such matters. It is also incumbent upon the Board that it partners with well-informed external organisations to assist in their review. Advisors need to question the influence of traditional benchmarking which evidence suggests has led to progressive adjustments to reward, particularly at-risk incentive reward, by following the practices of ever-changing industry leaders arising from the continuous leap-frog approach.

A further complexity is the extent to which the Board determine that reward practices in the financial services sector are influenced by practices elsewhere in the world and the extent to which those practices are influenced by the relative scale of the comparator global organisations.

Our recent research across all industries has revealed a general pause, if not decline, in the level of fixed remuneration paid to successor Chief Executives who are receiving lower salaries than their longer-serving predecessors.

Customer – Culture – Compliance

It is up to the Boards of leading financial institutions to initiate significant, if not radical change in reward outcomes.  This is essential to the process of executive renewal, of whatever proportions, as Boards review their practices and realign their culture to ensure a greater focus on the customer.  In this context, traditional benchmarking may not be the path forward but rather an examination of the relative change in work value through the hierarchy of the organisation.

While not endorsing inequality in reward, the opportunity may now exist for many Boards to provide the means for highly talented, capable and experienced women to assume a larger proportion of leadership roles in the sector.  Boards will need to ensure that new appointees are appropriately rewarded, rather than leaning towards the pattern of “extravagance” in reward as noted by the Hayne Royal Commission.

The challenge rests with the Board, not management.  In an earlier article (Governance : Front and Centre – July 2018) we note that a first step may be for the Board to establish a small group of independent, highly experienced staff to provide guidance and advice and undertake forensic examination of the organisation’s culture, any source of malpractice and the paths forward in changing any inappropriate practices.

At the time of preparing this article, we are aware of the decisions taken by the Board of the National Australia Bank in responding to criticism, with the Chairman engaging in the renewal process though stepping down in the near term when a successor has been identified and appointed.