Over the years, the average remuneration report has become lengthier and lengthier. Yet proxy advisors and investors are still lodging adverse votes on remuneration due to inadequate disclosure.
One problem is that the mandated disclosure is too prescriptive. It hamstrings companies that want to provide a concise description of how their KMPs’ remuneration is linked to performance – to provide a complete picture, they must first meet the legal and regulatory requirements and then provide additional disclosures that actually explain the situation.
One solution, which is currently being discussed in remuneration circles following a PWC paper on the topic, is to replace the current statutory table (which includes remuneration as defined by accounting standards) with another standard remuneration table or tables that are more useful to investors.
In the following sections, we outline the information Egan Associates would find useful as standard remuneration disclosure:
What is the remuneration opportunity?
This is the total amount of remuneration an executive is offered in a year, assuming the bonus and the long-term incentive granted in that year will be paid out in full (the maximum remuneration opportunity). The target remuneration opportunity is also informative, but it is the maximum that is indispensable.
Currently, the elements comprising the maximum remuneration opportunity are generally disclosed in a diagram or diagrams such IAG’s below.
Although it is possible to work out a total remuneration opportunity from the information in the diagrams, for time poor shareholders, it would be informative to know the actual total dollar amount of this opportunity, at least for the CEO.
A working table could be similar to the one below (where Jane Doe has fixed remuneration of $1,000,000 and John Smith has fixed remuneration of $700,000. Their remuneration mix is the same as BHP’s):
An important note to make is that any regulation mandating the disclosure of such information should ensure that the face value of the intended opportunity is disclosed rather than the fair value, which is inaccurate and understates the reward opportunity. For performance rights or shares, this would be the market value. For options a Black Scholes valuation should be used that does not account for the possibility that hurdles will not be met.
One complication is whether one off bonuses (such as a special bonus offered to an executive if they meet a project milestone or a retention bonus) should be included in this figure.
What pay did the executive realise during the financial year?
The first element of pay to be included in a table of “realised” pay (remuneration the executive receives during the year) is the fixed remuneration paid during the year.
If we are being true to our definition, the STI cash disclosed in this table would actually relate to performance in the prior financial year, because the payment for the current financial year’s performance is not generally made until after the end of the financial year. However, this could cause confusion in some quarters so the STI Cash to be paid for performance in the current financial year might be better. PWC gets around this problem by defining its version of realised pay, called current pay, as “remuneration that the KMP became entitled to during the current year and that was either paid during the year or will be paid subsequent to the end of the year.”
STI Deferred is simpler. It would include the value of STI deferred that vests to the executive during the financial year. Since STI deferred is generally in the form of cash, shares or performance rights, it would be easy to define this value as the market value of the STI Deferred at the vesting date. In the case of shares or rights, it will vary from the award value at the time of grant due to share price movement and dividends.
For LTIs comprising of cash and performance rights, a similar definition for realised pay would make sense – that is, the LTI that vested during the financial year. However, in the case of options, what to use as a realised value is more complicated. Do we record the value of options when they vest to executives or when executives exercise them?
Given executives’ ability to hold their options for a relatively long time in many cases, it is likely better to record a value at the vesting date, for example, the difference between the exercise price and the market value on the vesting date.
For the Jane Doe example above, the additional information required to complete the realised table is:
- Jane Doe’s package has been static for the last three years.
- This year, 55% of the LTI award from three years’ prior vests based on performance against criteria.
- The share price has risen 5% each year over the vesting period.
- The STI from two years prior was awarded at 90% and the STI from a year prior was awarded at 80% of maximum.
In this table, the Cash STI award relates to the current financial year, while the vested deferred STI is a combination of portions vesting from one and two years’ prior.
One question for such a table is how incentives that vest, but are still restricted after vesting should be handled. Or indeed, whether equity that vests to executives, but is not able to be traded due to lock out periods, can truly be considered as having vested?
There are likely also to be complications around when grants should actually be recorded as vesting to executives — the true date of vesting may be delayed due to Board time pressures pushing back necessary administration tasks or the calculation of performance against benchmarks.
What was the value of the bonus the executive earned for the year’s performance?
While the realised pay table captures the bonus that crystallises to the executive (including multiple years of STI), it does not capture the total bonus the Board will award to the executive for the current financial year’s performance.
This is important as it enables shareholders to consider pay for performance based on the financial results for the year.
The following table depicts Jane Doe’s bonus for the current year’s financial performance if she met target performance, leading to an award worth 120% of her fixed remuneration. It is similar to the STI Outcomes table many organisations disclose.
What is the value of the at-risk pay that the executive has on foot?
This comprises the value of STI deferred and LTI grants that have been awarded but not yet vested. Values could be defined as the market value (for rights or shares) or Black Scholes value (for options) at the end of the financial year.
Additionally, the grant date and vesting date (or the performance period) would be useful, as it would allow the calculation of an annualised value of the executive’s LTI based on multiple years’ grants rather than just one.
Using the Jane Doe Example, a table could look like this:
Complications with this table include:
- The actual timing of vesting dates could significantly affect this table, with the same complications arising as mentioned in regards to the realised pay table.
- The table above will not include the STI deferred award that will be made just after the financial year is completed, nor the LTI grant to be made in coming months. This produces a certain lag. The STI deferred grant could likely be captured if the reference date is changed.
If the above tables are disclosed, there will be a good understanding of executive remuneration, with information provided on:
- Opportunity: What the company’s ongoing remuneration intent is for the executive
- Bonus: What the company actually awarded to the executive for performance during the year.
- Crystallisation: What the executive actually received (realised) during the year.
- At risk- holdings: What the company can expect to pay to the executive over the long term if performance conditions are met.
Yet the complications we raised in this article, and others we have not mentioned, show that attempting to create a standard disclosure that will suit all companies is extremely difficult.