Market Update: Earnings Season FY21
Under pressure
FY21 earnings season + second year of a Covid-19 impacted environment = repeat of FY20 remuneration outcomes, right? Dear friends the answer is “yes and no”.
Last year we saw the emergence of a multi-speed economy with the economic impact of the pandemic playing out in very different ways across different industries, with some companies forced to come to a grinding halt (Qantas, Sydney Airport) and others doing all right as consumer spending was redirected to online and essentials (Kogan, Woolworths, Coles, JB Hi Fi).
That said, even for those that fared “well” in 2020, there was a general level of restraint with respect to executive pay as, in the early months of the pandemic, no one wanted to be the loser in the end. Boards weighed up the optics of providing generous bonuses against the broader social impacts and uncertain economic outlook presented by the pandemic – and for those that did not, some had a misfire where they had been recipients of Government support such as JobKeeper (Nick Scali, Harvey Norman).
So, as the FY21 reporting season unfolds, it begs the question – are Boards still under pressure?
Fixed pay – the return of the millionaire waltz?
Last year’s swathe of temporary executive pay / director fee reductions and pay freezes across the broader workforce has gone as quickly as Flash Gordon. We now see a return to fixed pay increases in FY21 for employees more generally across many industries (including for some a little catch-up on 2020) which have flowed through in many cases to executives though usually amidst a backdrop of good company performance (CBA, Fortescue Metals). In addition to those who increased pay in FY21, many others who may not have increased this year (and/or have had mixed levels of performance) have flagged that fixed pay increases will be made or reviewed in FY22 (Wesfarmers, Brambles, BlueScope). Even the companies in hard times will have to assess pay increases this year so as not to lose key talent.
Director fee increases resumed but to a lesser degree (CSL, WiseTech Global), perhaps a sign that Boards are prioritising keeping their executives happy after a less rewarding FY20, or alternatively recognising that too many increases (ie for both executives and directors) is more likely to attract criticism and it is better to adopt a staged approach so as not to tempt a showdown from critics at the AGM.
STIs – I want it all
Last year many Boards were forced to assess the appropriateness of formulaic STI outcomes, and where necessary, to intervene. This was particularly so where outcomes were considered to have been ‘boosted’ by the pandemic which resulted in Boards exercising downward discretion (Woolworths, Ansell), or where they did not align with company performance and shareholder experience (the Viva Energy Board zeroed out the financial component of the STI scorecard on the basis it did not reflect shareholder experience).
This year, ‘business as usual’ or more of that jazz has resumed with many delivering healthy STI outcomes, particularly where it can be substantiated with sound company performance (CBA, WiseTech Global). However some Boards are looking at the scorecards, if not to tear it up, by intervening with a flick of the wrist to:
adjust downwards for performance assessed as being due to market tailwinds (Coles, Fortescue)
adjust downwards with respect to non-financial measure outcomes where broader business issues arose for which executives were held responsible (ASX, Transurban)
reduce outcomes to zero to match the shareholder experience (AGL, Challenger).
Indeed, pain is so close to pleasure.
Boards are spending a lot of time and energy enhancing their STI disclosures in response to criticisms from external stakeholders (ie negative votes, or even strikes), particularly around STI targets and outcomes (AGL, Domino’s, Challenger, Star Entertainment, Lendlease). Though increased transparency may quell the back chat, we are also cautious of rushing headlong into too much disclosure as Boards need to consider commercial sensitivity of disclosures, particularly around financial targets.
LTIs – was it all worth it?
Last year we saw some creativity in addressing the issue of LTIs or retention arrangements in the context of an uncertain, and difficult to forecast, economic outlook. This resulted in approaches stretching from a portion of the LTI being delivering in restricted equity (Vicinity, Origin, CBA), recovery awards (REA, Aristocrat) together with retention awards to lock in talent where LTIs on-foot had been blown up due to the pandemic (Sydney Airport, Qantas, Scentre).
This year the opportunity for true bespoke arrangements appears to keep passing the open window. As another one bites dust, the pendulum has swung back to traditional LTI grants.
There is however some disparity in how companies have revisited LTI design decisions made last year, such as:
· Seven Group Holdings has maintained relative Total Shareholder Result as its sole LTI measure after having originally (pre-pandemic) intended to introduce an Earnings Per Share measure in FY21.
· Transurban removed its Free Cash Flow measure in FY21 due to difficulties with target-setting in unpredictable market conditions and have not reinstated it in FY22.
· Nine Entertainment will revert to assessing Earnings Per Share performance on a cumulative annual growth rate basis, as opposed to the point-to-point assessment introduced for FY21.
· Corporate Travel Management will continue to feature Share Appreciation Rights in its remuneration framework in FY22 while its business continues to recover.
ESG – is this the world we created?
Shareholders are calling for action this day and STI (and in some cases LTI) performance measures tied to ESG targets are on the rise, with new entrants including South32 (20% of FY22 LTI based on climate change and portfolio transition measures), IOOF (10% of their new hybrid plan is an ESG scorecard) and CSL (overarching measure coming in FY23).
BlueScope and AGL have also maintained their ESG measures, though AGL has reduced the weighting of those in the LTI following shareholder pushback last year. Santos also disclosed earlier this year that in addition to their climate measure (5%) they have added a low carbon fuels initiative (7.5%) to their FY21 STI, such that 12.5% of their STI scorecard will be ESG-related.
Similarly, Rio Tinto disclosed a proposal to incorporate ESG measures (including climate, diversity and inclusion and cultural heritage management) into their FY21 STI with a weighting of 15%. This will be in addition to their existing safety measures (20%) such that ESG and safety will have a combined weighting of 35% in Rio Tinto’s STI scorecard.
As stakeholder pressure for Boards to play the game in relation to ESG is only increasing, we expect to continue to see a rise in the number of companies linking executive reward to achievement of ESG goals.
We are the champions (?)
Shareholders are waiting for the hammer to fall on remuneration arrangements for some departing executives. Some are asking “what does it take to be considered a ‘bad leaver’???”, particularly with the likes of Rio having been called out on this issue and Crown making headlines for its decision to treat many of its departing executives as ‘good leavers’ for remuneration purposes (despite their exit being in the wake of a number of corporate scandals and Royal Commission inquisitions)?
The challenge for Boards continues to be that there is not one vision as to how to balance shareholder interests and proxy advisor perspectives in one hand, and executive retention, motivation and endeavouring to treat people fairly on the other. Many directors would be excused if they think “I’m going slightly mad”.
As results continue to be released and companies commence engagement with stakeholders ahead of their AGMs, we will continue to track those with a kind of magic and those that are death on two legs.
In any event, the show must go on.