The Changing Game of Executive Pay: COVID Revolution or Evolution?
This year has not gone to plan
2020 has certainly not dealt us the hand we were expecting!
As the world has been gripped, both psychologically and economically, by the roulette wheel of the COVID-19 pandemic, the ensuing recession does not parallel the GFC. Some companies have had their operations brought to a grinding halt (eg Ardent Leisure, Flight Centre), some have made the best of what was served to them (eg Coles, Ansell) while others have escaped relatively unscathed (eg Wesfarmers, Fortescue, BHP) and others have been beneficiaries of the rapid change in consumer buying behaviours (eg JB Hi Fi, Afterpay, Kogan).
Differing impacts on business have also meant very different remuneration impacts – from voluntary reductions in base salary, through to incentives that were otherwise on-track for vesting not vesting (or not vesting at the level expected), exercises of discretion (surprisingly) both up (drawing the ace) and down (or the deuce), and others where the Board has let the “cards fall where they may”.
Boards are continuing to assess the odds on executive pay in relation to:
previously agreed goals, and the incentives that would be paid if these were achieved, are being held or discarded with new cards being dealt (in the form of retention and recovery grants linked to post-COVID imperatives) as companies navigate this period of turbulence and re-orient themselves against a changing landscape;
current grants on-foot are rendered long shots as performance conditions agreed in FY19 and FY20 are no longer on the money and having no retention or motivational value; or
setting measures and targets for forward looking incentives (eg FY21 STI and LTIs, and beyond) which may be seen as a throw of the dice as the end of the pandemic, and economic rate of recovery, are still unknown.
To address these issues, we have seen Boards going for broke after a period of backing the favourites with remuneration decision making.
So, as the reporting season is unfolding, where is the smart money?
A DIFFERENT DIRECTION
In terms of the new games in town we have seen:
Recovery awards - Computershare introduced a recovery equity award in recognition that current LTI grants on-foot are not likely to vest and so do not provide a retention hook or motivation to the executive team. This has taken the form of share appreciation rights (SARs) to drive focus on share price recovery and ensure executives are rewarded commensurate to the improvement in share price performance from 30 June 20 to 30 June 2021 and 2022, with caps and off-sets to ensure there are no windfall gains should the existing LTI grants end up vesting. The SARs have also been incorporated as a part of the FY21 LTI (linked to a more traditional rights grant tied to relative TSR)
Origin and CBA have both proposed introduction of a restricted equity component into their LTI framework. Although Origin has withdrawn its initial proposal to grant 100% of the new LTI in restricted equity. While these coincide with this year’s pandemic, the key theme emerging for these proposals is that the LTIs are no longer valued due to nil/low vesting outcomes, and therefore offer no motivational value or retention hook for executives. In a bid to provide long-term shareholder alignment that is meaningful to executives, these Boards have reduced overall quantum as a trade-off for greater remuneration certainty.
Bendigo and Adelaide Bank have also sought to increase the equity alignment of their framework and removed cash STI, and replaced the LTI with a loan-funded share plan subject to performance conditions linked to strategy execution over four years, together with a more modest grant of performance rights subject to TSR hurdles over the same period.
However, playing the long shots can have its downside. Origin initially proposed a complete overhaul of their former LTI framework replacing it with a restricted equity grant only (with performance underpins) offered at a 50% discount to the former LTI opportunity. Following external stakeholder feedback, Origin subsequently withdrew this proposal and are instead now proposing a framework that includes both a performance tested component, as well as a restricted equity component.
IS NOW THE TIME FOR REVOLUTION, OR EVOLUTION?
Business disruption, change and transformation (including during a pandemic) are all times when Boards can take a step back and consider – how are remuneration frameworks operating? Are incentives focussing on the “right” things? Or do they unnecessarily narrow the focus? Remuneration frameworks should evolve with company strategy, and while in extraordinarily unique circumstances companies may be facing a 180 degree U-turn in strategic direction, it is more often incremental change that will come up trumps.
This year has cast a light on how rapidly “business as usual” can shift, but even then, when it comes to the topic of executive pay, stakeholders can be fickle and too much change can overwhelm. Setting out your strategy and how it may be evolving in response to the pandemic, together with how you intend to align your remuneration framework over time, may help engender both internal and external stakeholder buy-in as they will be brought on the journey. Focussing on the long game in remuneration design, but making short term moves to get to the end game are less likely to garner opposition.
As we continue to face into an uncertain economic outlook, a global recession and high rates of unemployment, Boards should be looking to make decisions that align executive reward with delivering on Company strategy – and not be afraid to split, stick or double down. However, perhaps not all at once.
When considering change, we encourage Boards to effect a revolution through evolution. Where will your Board place its chips?