FY23 Remuneration Cycle – The Predictions (Part 1)

FY23 Remuneration Cycle – The Predictions (Part 1)

As winter inches closer, it marks the start of another remuneration cycle for ASX June year-end companies – the first cycle free from COVID-19 lockdowns and border closures in recent years. Far from going in with Eyes Closed, we Dive into our crystal ball predictions as Remuneration Committees and reward teams turn their minds to the key issues for their company, whilst keeping one eye on their peers.

What are the Issues?

1) Testing of COVID-19 Long-term Incentive (LTI) Awards 

The time has come for LTI grants made in August 2020 to be tested (for those with three-year performance periods). Given the majority of grants were allocated at depressed COVID-19 share prices, LTI vesting values are likely to be higher than previous years.

In addition, vesting outcomes may also be higher as some companies adjusted their performance hurdles during the COVID period, including replacing internal financial measures with relative shareholder return (rTSR) only (eg Mirvac, Transurban and Stockland), due to the difficulty in setting long-term targets at the time.

What to consider in the upcoming remuneration cycle?

For those with an absolute total shareholder return (aTSR) measure, 2020 LTI grants are likely to be susceptible to ‘a rising tide lifts all boats’ scenario following the general ASX sharemarket recovery post-COVID. In communicating (likely) higher outcomes, will there be any downwards exercise of discretion to cap windfall gains (not due to management’s actions)? Where have LTI outcomes landed in previous years?

For those with an internal financial measure, inclusions and exclusions (given the large number of COVID related adjustments in recent years), to ensure they are a fair reflection of management’s effort, will be of interest. Have there been matters outside of management’s control which should be excluded (eg a capital raising during COVID-19) or included (eg any sale of assets)?

For those with an rTSR measure, outcomes are unlikely to be controversial given it is one of the preferred measures of proxy advisors. For LTI plans assessed wholly against rTSR, a measure sometimes sending Shivers down management due to its unpredictability, is FY24 the time to introduce a second measure as the COVID-shadow difficulties of target-setting subside?

2) The Last Strong Year of Annual Bonus Outcomes

Short-term incentive (STI) outcomes generally paid out handsomely in FY22, with over 50% of ASX 100 companies delivering an ‘above target’ result. This was in stark contrast to the COVID-19 affected years where lower STI outcomes and the exercise of downwards discretion by Boards was common amongst those most impacted by the pandemic.

As operations return to business-as-usual, will high STI outcomes persist in FY23? With the consumer price index (CPI) and interest rates at their highest in over a decade, will macroeconomic conditions eat into annual bonus outcomes?

What to consider in the upcoming remuneration cycle?

Given high inflation and interest rate rises have a ‘lag effect’, 2023 STI outcomes may scrape in before their full impacts are realised, for some. For others considering the use of positive discretion to reward management’s effort (despite falling short), Boards may Collide with external stakeholders, as we learnt from 2022 AGMs (eg Downer EDI and Cleanaway). 

With an eye to the future, what should be the target-setting approach for the FY24 STI? For companies expecting unhappier times, are year-on-year growth targets even probable? Is now the time to review measures and weightings in the STI scorecard? For those contemplating providing flat or lower guidance than FY23, how will you construct your threshold and target levels of performance (as proxy advisors hate the concept of receiving the same outcome for lower performance)?

3) Fixed Pay Increases in an Inflationary Environment

Last year, retention was the word of the year. This year, it is inflation. Whilst the unemployment rate remains at historically low levels (3.5% for the March 2023 quarter), the easing of border restrictions and record levels of migration may act as a counterbalance to ease wage pressure slightly.

Although wage pressure will continue to persist in certain industries and roles, for the rest of the pack, with CPI sitting at 7%, is delivering a real wage increase a realistic (or financially sustainable) expectation?

What to consider in the upcoming remuneration cycle?

To minimise the business disruption which turnover brings, retaining high performing employees is still a valid priority. With many companies turning the screws on hiring, particularly in the technology sector, it is more likely that the best and brightest will be the ones with the option to leave.

Before it becomes a case of You Need Me, I Don’t Need You, is the best way to retain The A Team via traditional fixed cash increases or targeted retention equity grants? Anecdotally, we expect 3-4% to be ‘the norm’ for FY24 fixed remuneration budgets, contrasting to last year’s flurry of off-cycle fixed pay reviews and 10-20% premiums paid for in-demand roles.

Given 3-4% is well below CPI, how will this be communicated to employees? Prior to the current inflationary environment, CPI had been no higher than 3% for over a decade.    

4) ESG Measures Beyond the Carbon Heavy Sectors  

Whilst ESG measures in incentive plans appear here to stay, environmental measures have thus far been skewed towards STIs in carbon heavy sectors, where emission reduction targets are more front-of-mind. As Australia plays catch-up to the UK, companies have gone beyond traditional employee engagement, diversity targets and customer satisfaction measures, which historically ticked the ESG box.

Instead, environmental measures are being incorporated into STI plans across sectors (eg NIB, Cochlear and Domino’s Pizza) and non-carbon heavy companies are also shifting the dial in the LTI (eg TPG Telecom has introduced a renewable energy target in FY23 (10% weighting) and, history being what it is, AMP has introduced a RepTrak reputation measure in FY23 (30% weighting)).

In the financial services (FS) sector, with APRA’s CPS 511 remuneration standard now effective (to break past Bad Habits), including the requirement to have a material weighting on non-financial measures, the stage is set for other FS companies to follow their international FS peers. Bendigo & Adelaide Bank is arguably the market leader in Australia, weighting 35% of its LTI and 50% of its STI on ESG measures.     

What to consider in the upcoming remuneration cycle?

As Australia inches towards its target of net zero emissions by 2050 and modern slavery continues to gain airtime, companies (regardless of industry) should consider how their sustainability plan can be tied into incentive plan measures. Does the sustainability plan have annual and multi-year targets, to serve as a guide for STI and LTI target-setting? What are the ‘right’ ESG measures for companies which don’t operate in carbon heavy sectors?

Externally, CGI Glass Lewis has stated that it is supportive of the inclusion of ESG measures in incentive plans as it can provide executives and shareholders with a clear line-of-sight to a company’s ESG strategy. Although we expect financial measures to continue comprising the majority of STI and LTI measures, a once tight leash on the use of non-financial measures has loosened. 

Time will tell whether we truly have a crystal ball, come August 2023. Part 2 awaits.