Executive remuneration: striking a balance

by 08 Apr 2010

There will be increased attention on executive remuneration in the wake of the global financial crisis. HR Leader examines some of the thorny issues and looks at how companies can get the executive remuneration balance right

The Productivity Commission recently released its Executive Remuneration in Australia Inquiry Report, which found that while Australia’s corporate governance framework is held in high regard internationally, there have been instances of large payments despite poor company performance, which have fuelled community concerns that executive remuneration is out of control.

The report suggested that corporate governance frameworks should be strengthened by removing conflicts of interest, through independent remuneration committees and improved processes for use of remuneration consultants, as well as promoting board accountability and shareholder engagement, through enhanced pay disclosure and strengthening the consequences for those boards that are unresponsive to shareholders’ “say on pay”.

More broadly, there has also been a collective intake of breath as companies consider how to respond to the global financial crisis and its aftermath, according to Lianne Hooper, a principal at Egan Associates. “A number of companies froze equity based incentive plans in the wake of the 2009 Budget and the wave of consultations and revisions which followed,” she says.

Coming off the back of salary freezes, Boards and CEOs have been cautious mapping a path into the 2011 financial year. Long-term incentive (LTI) plans have naturally been a focus of concern, and Hooper also notes that Boards are struggling with the reality of employees receiving an incentive while shareholder value has been significantly eroded.

“There is a new focus on the use of incentive gateways which are a reality check, if you like, where for example unless a base level of profitability is achieved no annual incentive will be paid. It was apparent to some Boards that although the key corporate financial metrics were not being delivered, incentive plans were triggering material payments,” says Hooper, who notes that “disconnects”, where they exist, are being addressed.

Hallmarks of good executive remuneration

While executive remuneration is constantly being refined, there are a number of hallmarks of good executive pay policies and practices, which executive remuneration committees would be wise to take note of. The most effective executive remuneration programs (which encompass salary, short- and long-term incentives as well as benefits) are designed to meet a range of objectives, according to Christine Deveney, a principal in the executive remuneration business at Mercer. “Remuneration programs must be competitive enough to attract and retain the right talent, and incentive plans must motivate executives to achieve the most critical near, intermediate and long-term priorities of the business,” she asserts.

Program payout levels should be reasonable in the context of performance delivered, and Deveney also states that remuneration programs must be responsive to shareholder interests by providing a meaningful relationship between pay and shareholder value creation.

Alan Jackson, an executive remuneration consultant with Hewitt, believes that a good model balances the needs of all stakeholder groups. In the end, he says balancing means discriminating and making clear decisions about priorities. “To what extent are we prepared to change the mix between short- and long-term incentive because of shareholder pressure?” he queries.

“If regulation is forcing us to decrease the value of a particular benefit should we compensate for it through another means if that means puts us out of line with other companies? Is the language we are using to describe various elements of the pay mix confusing our stakeholders? Good models are clear about what they are doing and more importantly, what they are not. They are unapologetic about what they are aiming to do and don’t sit on the fence delivering suboptimal outcomes to all.”

Executive remuneration committees and HR

With the turnaround in business performance over the past nine months, the challenge for executive remuneration committees and associated HR managers will come in managing expectations, Jackson points out.

“Many executives and indeed the Boards themselves have not seen a salary increase for at least two years. Moreover the incentives have not delivered the outcomes to which they have become accustomed,” he observes.

“In this context it will be important for the company to recognise the commercial realities and carefully calibrate incentive opportunities. How will shareholders react if the 2010 company performance and share price are up significantly on 2009 but remain below the high watermarks set in 2007 or 2008 while 2010 pay outcomes reach new heights?”

Jackson also says it will be important to maintain and monitor ownership stakes. “Make ownership matter. This can be achieved through longer vesting periods, mandatory holdings and/or post-vesting trading locks.”

Hooper warns against underpaying or overpaying in either the fixed or at risk element of remuneration, and she says that the challenge is in getting the risk weighting and balance right and recognising when the business needs are shifting. “Be a change partner and provide solutions,” she recommends.

“Remuneration is not a sacred cow; if it appears that something isn’t working shine a light on the issue and engage all stakeholders, but remember that remuneration is one link in a complex chain of employee engagement, talent management, delivery of corporate strategy over multiple timeframes, changing market and external pressures and more. To get remuneration right it has to considered in the broader context.”

5 pointers for getting executive remuneration right

Seek balance in executive remuneration delivery, including a more balanced focus on retention and reward

Use a more holistic approach to performance metric selection and target setting, and a more evenhanded use of short- and long-term compensation elements

Consider the relationship between risk and reward and, in particular, look for ways to ensure that rewards reflect sustainable performance results so that excessive risk-taking is not encouraged

With rewards resources scarce, differentiation of key contributors through rewards and career opportunities will be even more critical

Look for ways to apply the concept of segmentation to compensation and maximise the return on limited rewards dollars

Source: Christine Deveney, principal, Mercer