How to keep on top of executive pay

Michael Robinson considers developments in remuneration and provides insight to help directors focus on the key changes in 2015.

As 2014 draws to a close there is clear evidence of high levels of board skill in the oversight of key management personnel pay matters. This has contributed to an increase in investor satisfaction that is apparent in higher votes in favour of remuneration reports and fewer “strikes”.

Despite an expectation of economic growth below trend, the near-term outlook for director and executive pay is promising, given the government’s announced changes to equity plan taxation. Below, I examine the likely developments in 2015 which I hope will help directors focus on the most essential changes.

Back to the future
Under the federal government’s 14 October employee share scheme taxation announcement, much of what was possible until November 2009 may again be possible. While specific details are not available at the time of writing, the proposals seem to be very positive for the granting of options to directors and employees of start-ups, and possibly other cash-constrained companies, such as explorers. 

The changes, in combination with revised Australian Securities and Investments Commission (ASIC) class order exemptions (see the ASIC report on page 6 for more), should also permit more variety in the application of equity in director, executive and general employee remuneration for better shareholder alignment.

Non-executive director pay
Increases in base non-executive director (NED) fees are expected to remain constrained, despite pressures from director retirements and higher demand for independent directors on the boards of superannuation funds. At the same time, board renewal presents challenges as boards seek greater diversity from an apparently small pool, and wrestle with the prospects of technology disruption to their businesses.

Increases in NED fees are likely to be concentrated on adjustments to committee fees to reflect changing workload patterns. Remuneration committee fees have increased over several years, with the next focus likely to be the risk committee, given the ASX Corporate Governance Council’s recommendation (in its revised 2014 Corporate Governance Principles and Recommendations) that listed company boards should have a committee to oversee risk.

For 2015, we expect that overall director fee increases, inclusive of base board and committee fees, will be 2 to 3 per cent.

Executive pay
CEO and executive pay will continue to grow slowly and, in some segments, go backwards, for two reasons. The first is that slower economic conditions mean it is hard to justify increases when performance relative to prior years has reduced. Secondly, lower pay for new appointees has depressed the overall rate of market growth.

Typically, this second factor comes about because the rate of executive turnover increases in difficult economic periods and new appointees, usually promoted from within, accept promotion for less pay than their predecessor received. The greater proportion of new appointees reduces overall market levels against which jobs are benchmarked. Boards seize upon the data to justify limiting pay rises. In addition, economic anaemia often sees a reduction in realised performance pay and the prevalence of incumbents receiving any incentive payment.

Executive pay increases have not been homogeneous or uniform for at least a decade, and will continue to reflect disparities in performance between sectors and industries, and between companies within industries. The scarcity of supply and performance of executives in each company will influence the rate of pay increase. In addition, the fall in relative currency value may see a minority of companies having to pay more for international imports.

Boards will need to remain vigilant to ensure that performance hurdles are seen to be reasonable, remembering that proxy advisers compare performance targets against consensus analyst forecasts.

Modest executive remuneration increases are expected, with median increases in the order of 3 to 3.5 per cent. The rate of increase will vary between industries, and the differences will be more pronounced than in 2014 as the economy continues to rebalance away from resources to construction, infrastructure and exporters.

Investor issues and trends
Three years of the “two strikes” regime has helped ensure that egregious pay practices are now scarce. Board directors are more engaged with their stakeholders. Expectations are better understood. Differences are better ironed out. Disclosures are better. Practices have improved.

Institutional shareholders, guided by their proxy advisers, are still prepared to vote down remuneration reports but are shifting their attention to board performance and renewal. While winning support for the remuneration report will continue to require effort, directors will need to be able to respond to non-remuneration related questions during their engagement sessions.