Cycling Through Year-end – Key Remuneration Issues

As we enter the final month of the financial year for June year-end companies, Remuneration Committees and reward teams pivot their attention wholly towards the FY24 remuneration cycle.

While Australia is likely to have reached the crest of the cash rate cycle (at 4.35%) and inflation stubbornly trudges down to 3.6% in the March 2024 quarter (past the peak of 7.8%), the lag effect of these macroeconomic factors are likely to continue plaguing some companies come year-end.  

What are the issues?

1)     Real wage increases

The ongoing stubbornness of inflation means delivering a real wage increase will result in higher-than-average fixed pay increases. At the executive level, ASX 100 March-year end companies have generally delivered at-least-inflation fixed pay increases (e.g. Xero and ALS).   

What should you consider?

Whilst providing real wage increases to broad-based employees will not attract external attention, for those that appear in the remuneration report, shareholders apply a higher level of scrutiny.

While it is easier to explain above average pay increases for new executives growing into role or where responsibilities have expanded, an above-inflation wage increase for executives already on highly competitive fixed pay may be harder to sell to investors and proxy advisors.

Rather than providing a 3-4% fixed pay increase as part of the broad-based employee budget, companies may consider providing this type of increase to already competitively paid executives via an increase to incentive opportunity levels instead (e.g. short-term incentive (STI) or long-term incentive (LTI) opportunity). This approach does not further pressure fixed costs and can be sold to investors and proxy advisors as enhancing pay-for-performance.  

2)     Paying the same bonus for lower financial performance

To ensure management remained sufficiently motivated and focused on achieving pragmatic budgets, some companies set lower FY24 financial targets in a less robust economic environment. Whilst practical, some investors and even more likely, some proxy advisors, are unlikely to be sympathetic towards companies paying the same level of bonuses for ‘lower’ profits, particularly if accompanied by lower dividends and a lower share price.

What should you consider?

If your company is expecting the trifecta (lower profits, lower dividends and lower share price), you may consider the following to reduce the likelihood of being on a collision course with external stakeholders:  

• Moderating bonus outcomes, such as through the use of downwards Board discretion. Bonuses which are meaningfully below the historical average will be more defensible externally;  

• A one-off solution may be to defer a larger-than-usual portion of the annual bonus into equity, which would tie executives’ wealth to future shareholder returns and reduce cash outcomes. However, if bonus outcomes remain on par with historical averages, this alone may be insufficient to avert external scrutiny or the ‘against’ recommendation from proxy advisors; or  

• Where bonus outcomes are expected to be similar to previous years despite poorer financial performance, consider preparing an external engagement plan with major investors (to attempt to avert a ‘strike’ against the remuneration report).

3)     High vesting outcomes of non-financial LTI measures or retention awards

Where financial performance has been solid, there may be no cause for concern over higher vesting outcomes (and realised pay) from non-financial LTI measures and/or retention awards. However, where profits, dividends and/or the share price are lower, a level of external scrutiny may be expected on:

• The vesting of non-financial LTI measures – With the use of LTI non-financial measures moving beyond infancy over the past 3 years (e.g. Domain (20% weighting on delivery of marketplace strategy) and Orica (20% weighting on business sustainability), 2024 will see a number of companies with LTI awards tested against a portion of non-financial measures for the first time (e.g. Atlas Arteria and Viva Energy). Given non-financial measures have historically been viewed as ‘soft’, the quantifiability and robustness of targets may be closely scrutinised, particularly where financial performance has declined and 100% of the non-financial or strategic elements vest; and

• The vesting of retention awards – With a number of companies granting retention awards in prior years, generally to prevent poaching of talent, these retention periods are nearing their end and due to vest in FY24 (e.g. IDP Education and Northern Star). Generally, external stakeholders have been skeptical of awards linked only to continued service (but are more receptive of awards with a baseline performance test). Unfortunately, there is often an element of double jeopardy in these grants with proxy advisors, in particular, who criticise them on grant and again on vesting. Again, stakeholder engagement programs should tackle this issue head on.

What should you consider? 

For companies with solid financial performance, higher vesting outcomes (especially against non-financial or strategic elements) are less likely to be scrutinised and unlikely to be ‘fatal’ in receiving a ‘first strike’. In the case of retention awards, where these have successfully kept executives in place to deliver those improved financial outcomes, this should be emphasised.

For companies where financial performance has gone backwards, this will require stronger communication of what has been achieved to arrive at the vesting outcome and the link to long-term shareholder value creation (especially in the case of non-financial LTI measures) or reminding shareholders of the rationale of why the award was initially granted (to aid retention during historically tight labour markets).

As June year-end Board and management teams put the pedal to the metal, aligning remuneration decisions to your company’s profit, dividend and share price performance is more likely to generate external support later, come AGM season.