Future Thinking: Is There Life on Mars?
Looking back over the last 12 months, you would be forgiven for thinking ‘What in the world?’ when it has come to executive remuneration. The golden years appear to have passed, with COVID-19 challenging us all to be more creative in remuneration design. The delaying of target setting by Dexus, alterations to metrics (eg Transurban removing its free cash flow target), retention arrangements (Scentre Group), recovery grants (REA), novel instruments (Computershare granted share appreciation rights) and the special grant of three tiers of options at Webjet were some of the methods Boards adopted to address the limitations of ‘business as usual’ remuneration design during a year that was far from BAU.
As if in a moonage daydream the fog lifted and market practice and benchmark percentiles were suddenly distant cousins to pursuing bespoke solutions. Boards were laser focused on business continuity, including the importance of continuing to attract, retain and engage key executives to continue to steer the ship through the unchartered waters of a pandemic, even if it meant risking stakeholder push-back.
Change is on the horizon
The short-fall of traditional remuneration design (comprising fixed pay, short term incentives and long term incentives) has been exposed – in particular that they aren’t always recession or pandemic-proof. Particular pain points included for those companies where some part of the short term incentive is considered to be almost certain (and so de facto fixed pay) and those where the retention hook of long term incentives has been eroded – not just for 2020 but for the next few years because of the material impact of COVID on company financial metrics.
Even companies that were beneficiaries of the disruption were not immune. In these dollar days, Boards were forced to evaluate whether the formulaic approach to STI or LTI outcomes still produced the ‘right’ outcome given the experience of customers, suppliers, employees or the broader community.
For companies that faced a significant downturn, other components also needed to be considered; chief among them: retention. Part of remuneration design is to focus executives on pursuing short-term business priorities and to keep them ‘locked in’ to deliver the strategy over the long term. When a framework loses its motivation and retention power, it is typically because performance targets become unachievable well in advance of the testing date. If we are to learn a broader lesson from the past year to carry into the future, it is that the world can change quickly and that the best cure is prevention. Designing remuneration packages to withstand such heat will hold companies in better stead for the next big shock, whenever that may be.
So, where are we now?
The reality is that we are still in a state of relative uncertainty. JobKeeper ceases next month and unknowns remain about the long-term prospects across a number of industries. This backdrop continues to present challenges for Boards in selecting appropriate measures and targets to underpin executive remuneration design, but with 2020 acting as a circuit-breaker for Australian remuneration, there may now be a unique opportunity to make changes.
With continued focus on the sheer quantum of executive pay as the speed of economic recovery remains uncertain, Boards may need to get creative. Part of this may involve turning away from market practice and developing bespoke plans.
With continued pressure on salary increases, we may see cash base salaries stagnate. While the market had already moved away from CPI-style annual increases, rewarding a star and ensuring remuneration packages are competitive is still critical. Is there really any red money?
Can incentive opportunities be increased? In uncertain times this may be the literal dead man walking as it increases headline remuneration numbers without any certainty of fulfilling its objective of motivation and retention (if measures are too difficult to set).
While somewhat of a rebel, rebel - is it time to consider an annual grant of restricted equity in lieu of traditional cash increases? Or even to replace STI? There is a growing trend of restricted equity plans in the UK and they have long been a staple of the US diet. There is no doubt restricted equity’s recession-proof quality will endear it to companies that do not want to be put under the gun again anytime soon.
Ongoing scrutiny of STIs (in particular as many companies missed financial targets and paid out based on non-financial measures in 2020) and whether they are being delivered for ‘day job’ or ‘outperformance’, makes it increasingly difficult for Boards to traverse the different stakeholder expectations (executives tending to believe it is annual remuneration at risk and external stakeholders expecting these to be for outperformance), is it time to re-imagine STIs altogether? Whether it be replaced with the slow burn of restricted equity (issued at some discount) or replacing STI with an enhanced LTI with progressive testing?
While LTI design in Australia has historically been characterised by homogeneity, it may be time to re-assess whether ‘market standard’ metrics will carry your company forward, and whether it is time to fashion new performance measures aligned with strategy, or consider old measures in a new way to ensure vesting schedules are stretching, but achievable, for executives.
This may mean marching to the beat of your drum, such as by:
Setting targets up front while flagging that adjustments may be made, or results normalised, where the assumptions underpinning those targets have not held (whether that be material deviations in exchange rates, interest rates, commodity prices or other tangible assumptions);
Increasing use of relative financial measures against near peers? Or even measuring against a benchmark return; or
Incorporating an element of back to basics financial metrics around revenue, market share, customer and transaction numbers or even segmenting the growth of digital (hello spaceboy!) – those things that underpin the health of the business and financial outcomes this year or in the future.
Could this lead to a better future?
Effecting change
Those who proactively engage their stakeholders – both internal and external – will almost certainly have an easier time evolving. You may not always get universal support, but trying to appease all stakeholders simultaneously is rock’n’roll suicide.
There is no doubt that stepping outside as you shift away from market practice as a determinant of remuneration design, may feel like dancing out in space. Rest assured, tailoring your remuneration structure and its measures and targets to your business, will always be a hero.