In uncertain times, protests on pay often reflect wider fears about a company's future. Financial reporting that addresses concerns can help to avoid ugly scenes at the AGM
This article was first published in the June 2017 UK edition of Accounting and Business magazine.
Executive remuneration remains a potential flashpoint in investor relations, with ‘say on pay’ mechanisms providing a means for investors to register dissatisfaction with corporate performance. In the 2016 Australian AGM season, for example, there were eight first strikes and 17 no-votes of 10% or more against the remuneration report in the ASX 100, following a similarly difficult UK season earlier that year. A recent global survey of institutional investors by corporate governance consultants Morrow Sodali found that all respondents (representing US$24 trillion of assets under management) were prepared to vote against a company that exhibited poor pay-management practices.
So what’s behind protests on pay? Basically, performance – and, in the UK, the public’s perception of inequality, a sentiment fuelled often by the media. In an uncertain climate, investors in particular are demanding better explanations of how management performance is measured and how it contributes to shareholder returns. Many of the companies subject to no-votes in 2016 operate in sectors facing significant uncertainty, particularly those from the financial services and resource sectors. The stated motivation for the protests is, almost invariably, concern that executive pay did not reflect poor or uncertain corporate performance.
It’s often not about remuneration. A no-vote is a shot across the bows of the board by disgruntled investors. It generally reflects a broader dissatisfaction with management or the board; remuneration structures and outcomes that might sail through other AGMs become a concern. Of the eight first strikes in the ASX 100, seven were against the background of poor share price performance, recent scandals or concerns about the company’s ability to deliver future results.
Culture and risk
Concerns around corporate culture and risk management often underpin investor dissatisfaction. Boards may be seen as passive or complacent, unwilling to hold senior management to account. Where pay outcomes do not match performance or where pay has grown substantially, investors may conclude that the board is hostage to management on pay issues – and may well be similarly incapacitated on issues of culture and risk management.
At the same time, there is a strong vein of cynicism about the inclusion of non-financial performance measures in executive pay. These are sometimes seen as low-risk and therefore a means of rewarding management for simply doing their job.
There are a number of lessons for management in bringing shareholders along with them:
- Join the dots. Much of the commentary around remuneration involves complaints about unclear, incomplete or inconsistent information. Investors never consider the remuneration report alone. Despite this, companies often produce remuneration reports in isolation from other communications.
Disclosure of performance measures and links to shareholder value in the remuneration report should be in lockstep with the risk and strategy discussions in investor briefings and the annual report. A complete and consistent story reassures the market that the board and management actually know what they are doing.
Demonstrating how non-financial measures of performance contribute to shareholder value is a particularly thorny issue. Investors are wary of the potential for loosely defined measures to act as a means of delivering risk-free virtual pay rises. Specifics about the calculation and measurement of non-financial performance may be particularly warranted where such measures are new, linked to a substantial proportion of potential earnings, or otherwise contentious.
- Take all year. Ongoing engagement is critical. Surprises – even positive ones – have the potential to undermine confidence in management’s understanding of the environment and of the business itself. The same applies to remuneration. Where significant changes to remuneration are being considered, or where outcomes are on track to vary from previous years, or from this year’s results, early engagement with investors and proxy advisers can be helpful to head concerns off at the pass. For companies that struggle to get the full attention of market commentators and investors – for example, many small caps and recent IPOs – telling a clear and consistent story becomes even more critical.
- Lead from the top. Many companies produce the annual report by binding together a set of disparately produced ‘chapters’ without any attempt to meld them into a consistent story. The root cause of this is usually structural: each functional area produces its own material, and the owners may resist attempts by investor relations, corporate affairs or other functions to encroach on their territory.Intervention by the CFO, CEO or the board is almost always required for this situation to change.
- What’s needed – not what’s required. Despite the sensitivity of the topic, the remuneration report is frequently treated as a compliance exercise. What’s more, it’s often the only communication with the market on executive pay. Put yourself in the shoes of your investors. Consider what information they are likely to ask for – or even better, ask them what it is they want to know. Aim to weave that information into a clear and consistent story, and any compliance-led detail that isn’t of interest can be filled in if necessary.
Vanessa Richards, journalist
"Many annual reports are a set of disparately produced 'chapters' bound together, with no attempt to meld them into a consistent story"