EY Pay Perspective 2017 Executive and Board Remuneration Report: Turbulent times in executive remuneration
Contents Executive summary Page 3 01 2016: influences on remuneration 02 Remuneration mix and structures Page 4 Page 5 03 Short-term variable pay 04 Long-term variable pay Pages 6 7 Page 8 05 Fixed remuneration 06 2017: a year to focus on performance Page 9 Page 10 22
Executive summary There is an obvious intuitive appeal in saying that an effective link between pay and performance for executives is important. In our 2017 Executive and Board Remuneration Report: Turbulent times in executive remuneration, we look at how the pay and performance link is playing out in Australia as companies face a backdrop of increased political uncertainty, challenging performance and vocal shareholders. Some companies are reconsidering executive remuneration design. For example, moving away from the market prevalent approach of fixed remuneration, short-term incentive (STI) and long-term incentive (LTI). Others are changing performance measures in their existing structures. We start with a different perspective. To decide what structure is most suitable, we believe it is critical to consider how value is created in your company and decide where and how you should link your remuneration structures to value creation. Defining this link to performance will inform the selection of the best remuneration structure for your business. For this report, we analysed the remuneration structures and payments for the top 100 companies¹ in the ASX200, to test our views on how executive pay should reflect performance. Our results are below. Although some companies are considering how to use the components of remuneration in different ways, the majority of the top 100 use a construct of fixed remuneration, STI and LTI. Our findings have therefore been presented within these categories. Our view Remuneration mix should be skewed towards variable pay at the executive level. Across the market, there should be variation in the structures used to deliver executive remuneration. Designing your executive remuneration approach around your value drivers and your view of critical performance is the key ingredient. It is equally important to have a link to performance in both: 1) the STI design 2) STI payment outcomes Payments should consider both overall and individual performance. The LTI design, incorporating performance measures and vehicles should be company specific and relevant, implying there should be variation in the market. Fixed remuneration should reflect company complexity, the individual s experience and role requirements. What we found Remuneration mix is skewed towards variable pay, albeit to a lesser extent than in some other countries (e.g. the US and UK). Approximately 10% of companies have adopted an alternative structure, and the speed of change has been slow. STI design is clearly performance focussed. But it may not be entirely effective in aligning outcomes with overall performance. Across the market, STI payments do not fluctuate significantly year-on-year. Financial performance was lower in 2016 than 2015, while STI payments (as a percentage of target) were higher. The top 100 companies are at different stages of their strategy and business cycle and in a wide range of industries, but approximately 70% of the market operate an LTI with similar performance measures and vehicles (relative TSR and performance rights respectively). Fixed remuneration does tend to reflect many factors - including experience, as we continue to see new incumbent CEOs receiving less pay than their predecessors. ¹The top 100 refers to the largest 100 companies in the ASX 200 by 12 month average market capitalisation. All analysis refers to the top 100, unless stated otherwise. EY Pay Perspective 2017 Executive and Board Remuneration Report 3
01 2016: influences on remuneration 2016 saw turbulent times in executive remuneration, driven by the following factors: Internal pressures 2016 saw new political and ongoing economic uncertainty. Against this backdrop, some companies had difficulty setting performance targets, experienced a lack of variability in remuneration outcomes and questioned the effectiveness of the STI to deliver the right messages. Talent market Remuneration was used actively as a tool to attract (and help retain) the right talent and to reinforce the company s desired behaviours and culture. External views While there were divergent views between investors around remuneration structures and measures, the AGM season aired some common concerns, primarily around whether executive remuneration outcomes reflected whole of company performance. The broader community expressed concerns over the amount paid to some executives. 4
02 Remuneration mix and structures Your performance emphasis should be customised to your business drivers EY view Remuneration mix should be skewed towards variable pay at the executive level. Across the market, there should be variation in the structures used to deliver executive remuneration. Designing your executive remuneration approach around your value drivers and your view of critical performance is the key ingredient. Figure 2: alternative remuneration structures Consistent with our expectations, the market continues to have a heavier weighting on variable remuneration than fixed remuneration (figure 1). Figure 1: target remuneration mix continues to be weighted to variable remuneration for all roles² BUH CFO CEO 31% 38% 40% Average fixed remuneration as a % of total remuneration Average variable remuneration as a % of total remuneration The way that variable remuneration is delivered, and your performance emphasis, should be customised to your business value drivers. As outlined in figure 2, companies may consider changes within existing prevalent structures or may consider entirely different structures. 69% 62% 60% Short term tactical focus, Remove performance based LTI Fixed remuneration + STI (with STI partly delivered in deferred equity) Short and long-term incentive plan: Prevalent structure Majority of ASX 200 listed companies retain this approach Fixed remuneration (cash) STI (cash) (likely with deferral into equity) LTI (equity) with TSR and another Medium to long-term strategic focus Fixed remuneration + LTI Fixed remuneration + STI (both elements delivered partly in equity) LTI without relative TSR -term performance focus LTI with company or milestone measures Fixed remuneration + combined variable remuneration incentive may be delivered partly in equity For some companies, the market prevalent approach will continue to work, potentially with further customisation of specific design elements (e.g. performance measures or performance periods). For other companies, an alternative framework could be considered if it suits the business circumstances and strategy. Approximately 10% of companies have adopted a different structure, and the speed of change has been slow. Common approaches are the provision of some fixed remuneration in equity or a combination plan that amalgamates the STI and LTI into a single plan. We do see some variation in the period over which remuneration is delivered (e.g. the average time to receive variable remuneration in the retail sector is 2 years, compared to 2.7 years in the finance sector). However the variation is not to the extent we would expect. We expect the slow pace of change to continue in 2017, as companies continue to consider revised structures. We do not expect this will result in a radical shift in practices in the near future. ² Chief Executive Officer ( CEO ) Chief Financial Officer ( CFO ) Business Unit Head ( BUH ) EY Pay Perspective 2017 Executive and Board Remuneration Report 5
03 Short-term variable pay There is an opportunity for companies to strengthen the link between performance and payment outcomes EY view It is equally important to have a link to performance in both: 1) the STI design 2) STI payment outcomes Payments should consider both overall and individual performance. More focus should be placed on the whole of company assessment of performance. Good decision-making in determining incentive outcomes requires performance information to be drawn from a range of perspectives and considered on a timely basis. STI design STI frameworks are linked to performance, with most companies operating a scorecard which measures both financial and non-financial measures. While a scorecard presents a balanced view of performance, the discrete measurement of multiple components is more likely to result in payments consistently around target level. The whole of company performance overlay is important to determine where adjustments may need to be made to payments derived from the underlying scorecard. Short-term performance measures tend to be consistent across the market, most commonly, profitability (figure 3) and strategy-based measures (figure 4). The three most prevalent measures in 2016 are presented in the relevant figures. Figure 3: profit/earnings is the most prevalent financial measure Figure 4: strategy-based measures are the most prevalent non-financial measure Profit/earnings 94% Business plans/strategy/growth 70% 88% 58% Expenses/cost management 35% People/values/culture/behaviour 65% 26% 58% Return 33% Safety/health/environment/sustainability 58% 34% 52% 2016 2015 2016 2015 The majority (69%) of companies are retaining ongoing exposure to company and share price performance through the use of STI deferral. The most common vehicles for deferral continue to be rights and shares (figure 5). Figure 5: rights and shares continue to be the primary STI deferral vehicle 3% 8% 8% 8% 38% 41% Rights Shares Other Cash 2015 48% 48% 2016 6
STI payments At an aggregate market level, the focus on performance that is present in STI design is not reflected in the level of STI payments. Financial performance in 2016 was lower for most companies than 2015³. Consequently, we expected lower (or potentially a broader range) of STI payments as a percentage of target. The market data, at an aggregate level, does not indicate a strong downward movement or a broadening of payments (figure 6)4. The payment range narrowed in 2016, with payments: Figure 6: STI payment ranges are narrowing STI payments as a percentage of target opportunity 180% Increasing at the: 10 th percentile 25 th percentile 50 th percentile Decreasing at the: 90 th percentile 75 th percentile However, while the aggregate market may not exhibit significant volatility, we do see some volatility at an individual company level. For example, 25% of companies did not make an STI payment at some point over the last 5 years. 140% 100% 60% 20% 0% 2012 2013 2014 2015 2016 10th percentile 25th percentile 50th percentile 75th percentile 90th percentile There is an opportunity for companies to strengthen the link between performance and payments. To strengthen this link, management and the Remuneration Committee have different roles to play: Management may: Undertake a critical assessment of performance at the end of the period. Information should be provided to the Remuneration Committee incorporating both the view of performance within the plan design plus the whole-of-company performance as seen by shareholders (i.e. financial, operations, risk, culture and reputation which are potentially not included in the plan design). Ensure the information provided to the Remuneration Committee is ongoing and considers all remuneration elements at the same time, rather than discrete decision making regarding individual remuneration elements. The Remuneration Committee may: Test and validate information from management, including considering whole of company performance. Analyse the implications for payments when results are conflicting (e.g. under achievement of financial performance and over achievement of non-financial performance could still result in target payments for some companies). Ensure clear messages are given to executives around the level of performance expected to receive payments and, once payments have been determined, how performance has been considered in the determination of outcomes. Undertake clear external communication and drive the shareholder engagement process. ³Sixty-five percent (65%) of top 100 companies experienced lower TSR in 2016, 56% experienced lower EPS growth and 55% experienced lower Operating Income growth. 4CEO STI payments for any company in the ASX100 at 1 December, over the past five years. EY Pay Perspective 2017 Executive and Board Remuneration Report 7
04 Long-term variable pay Uniformity of measures and vehicles is in contrast to our understanding of the variation in business strategies across the market EY view LTI design, incorporating performance measures and vehicles should reflect company needs. The significant use of features such as performance rights and relative TSR suggest LTI design is undertaken without sufficient consideration of its alignment to business strategy or the aims of the plan. Figure 7: TSR is the most prevalent performance measure The majority of companies continue to use relative TSR as a performance measure (potentially combined with a second measure) (figure 7) and performance rights as the plan delivery vehicle (figure 8). This uniformity of measures and vehicles infers there is a similar long-term strategy across the majority of companies which is in contrast to our understanding of the variation in business strategies across the market. Figure 8: performance rights are the most prevalent plan vehicle TSR 94% Performance Rights 92% 85% 81% EPS 45% Share options 14% 42% 17% Return 27% 39% Other 5% 4% 2016 2015 Phantom/Cash 5% 12% Performance shares 2% 4% 2016 2015 TSR can reflect a different performance focus, depending on the comparator group selected and the way performance is measured. We suggest companies are clear on the purpose of their TSR measure before selecting a measurement approach, for example: Example performance measure Relative TSR measured against broad, multi-industry comparators Relative TSR measured against select industry comparators ( peers ) Absolute TSR Implied strategy Broad comparison Shareholders can allocate their investment funds across a broad group of industries/companies. We want to be a preferred investment choice across that group. Industry comparison We will outperform relevant peers (typically those in our industry ) when investors put money into our industry, we want them to invest in us. Outcomes achievement We want to deliver positive shareholder returns regardless of market dynamics, to reflect our shareholder s expectations. 8
05 Fixed remuneration Remuneration increases continue to be constrained EY view Fixed remuneration should reflect company complexity, the individual s experience and role requirements. Figure 9: median fixed remuneration remained relatively stable across all roles Fixed remuneration does reflect company complexity and individual experience. In 2016, we saw a flat market for fixed remuneration (figure 9) as new incumbent CEOs continued to be paid less than predecessors. Further, increases across the market remained conservative (figure 10). For fixed remuneration, increases were 3% or less across CEO, CFO and BUH roles (individuals in the same role year-on-year). Figure 10: median remuneration increases continue to be constrained (percentage increase in target remuneration for same incumbent roles) ($'000s) 7,000 6,000 6,222 6,128 Element Fixed remuneration CEO CFO BUH 2.3% 3.0% 2.6% 5,000 Total remuneration 1.4% 4.7% 1.7% 4,000 3,000 2,000 2,169 2,417 2,251 2,486 1,000 0 2015 2016 2015 2016 2015 2016 CEO CFO BUH Fixed remuneration Variable remuneration EY Pay Perspective 2017 Executive and Board Remuneration Report 9
06 2017: a year to focus on performance Remuneration Committees will make hard decisions about how, and how much, remuneration is paid Remuneration Committee membership is not for the faint-hearted, with executive remuneration becoming a high profile statement of a company s acceptable level of performance, for the company overall and its individual executives. Over the coming year we expect more Remuneration Committees to exercise informed judgement over STI payments. More alternative approaches, but not the majority Companies will re-think structures and/or performance measures. There will be enhanced consultation on and communication of, any changes. We believe the rate of change, particularly in terms of changing structures and measures will be gradual. Refreshed engagement with investors We believe a new perspective on interacting with shareholders is required. We believe the right way forward is to adopt a mindset which recognises shareholders as both customers and owners and to drive a proactive communication approach that focuses on: A clear explanation of how the company creates shareholder value and how the remuneration approach supports this An explanation of what key remuneration decisions were made and why Simple and easy to understand Remuneration Reports An emerging focus on assessing remuneration in the context of the purpose and culture of the company A company s remuneration framework and, in particular, incentives have a substantial influence reinforcing company purpose and behaviours. We expect companies to assess critically the current and potential consequences of the remuneration framework, both on performance and culture. 10
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