GRG Remuneration Insight 116

by James Bourchier, Peter Godfrey & Joshua Tindell

Introduction

It is this time of year when many executives and Board members start thinking about writing the Remuneration Report (“Rem Report”) for inclusion in the Annual Report. It may feel like a burden for many, often because of the increasing complexity in balancing stakeholder requirements including; the Board, Finance, HR, Investor Relations, Auditors and the Company Secretary – and that’s just the internal stakeholder pressures!

In this Insight we look at the best Remuneration Reports observable in the market, hot trends, strategies to manage the diverse stakeholder pressures while streamlining the Remuneration Report and ensuring compliance while maximising votes in support of the Remuneration Report resolution (managing Strike risks).

Who is your Audience and What is the Purpose of a Remuneration Report?

An important consideration is who is the audience and what is the purpose of the Remuneration Report as there are often multiple audiences and purposes that must be balanced to achieve an optimal outcome, noting that the balance can change from year-to year:

  • Compliance Audience – this highly visible group (internally often Directors, the Company Secretary, CFO, Legal Counsel) is typically focussed on compliance with statutory disclosure requirements to satisfy an external regulator audience (including auditors), aiming to avoid breaches that will have repercussions, and often seeing any additional disclosure as “risky and unnecessary”. The main considerations here are:
    • Corporations Act (see Section 300A and Corporations Regulation 2m.3.03 for extensive disclosure requirements),
    • ASX Listing Rules (see Chapter 4 regarding the need to report, but little influential detail there), and
    • ASX Corporate Governance Council’s Principles and Recommendations (ASXCGCP&R4 – note: relatively new 4th Edition has been released), see Principle 8, and “where to make corporate governance disclosures”.
  • Institutional Shareholder and Proxy Advisor Audience – this somewhat disparate group is probably most visible as proxy advisor reports that influence voting patterns at the Annual General Meeting (AGM) and can cause a “Strike” leaving the Board with legal obligations and reputational damage. Their focus is typically on transparency, completeness and clarity, as they are (or represent) the truly sophisticated investors that wish to make fully informed decisions based on the details. Here we note that:
    • Most proxy advisors and some institutional investors publish guidelines for practices and disclosure that will improve the likelihood that they will recommend in favour of the Remuneration Report resolution,
    • Most such guidelines or groups call for disclosure above and beyond the requirements of the statutory audience, and
    • Often it is necessary to respond directly to feedback from these groups or risk a strike.
  • Retail Shareholder Audience – this often overlooked audience is typically focussed on simplicity and clarity, often in a way that conflicts with the requirements of the other two main audiences; statutory requirements are often unintuitive, accounting standards are illogical, such as in the case of AASB 2, and the transparency and completeness institutional investors seek is often seen as “overwhelming”. Here we note that:
    • Often a “plain English” explanation is required,
    • The Australian Shareholders’ Association (ASA) is the peak body representing such shareholders, and they have their own guidelines, but retail shareholders may even find the ASA’s requirements overwhelming (e.g. preference for multiple remuneration tables showing statutory data in one, and “realised/actual” remuneration in another, and
    • Pictures, charts, diagrams and tables are often preferred by this group compared to detailed technical explanations.

Are you Getting the Balance Right to Maximise Support from Shareholders?

The Compliance Audience is often mainly internal, and often given the greatest weighting in Remuneration Report preparation, despite the fact that this group is the least likely to influence the outcomes for the Remuneration Report resolution at the Company’s AGM, which is the primary real world consequences of report preparation.

It should be noted that compliance is a legal issue (purview of the Company Secretary and Legal Counsel) with only a minor accounting contribution, to the extent that numbers required to be disclosed by regulation are covered by an accounting standard (mainly AASB 2 and AASB 124, and typical financial performance reporting standards etc.). Many companies appear to rely on their auditor to guide their preparation of the Remuneration Report, despite the fact that expertise of auditors is generally compliance and will not serve the needs of other audiences. Given the propensity of auditors to recommend against making any disclosures that are not covered by statutory requirements or accounting standards, it could be said that they too are often given undue prominence. The impact of the auditors is particularly seen at the lower end of the market, with larger companies tending to make more extensive non-statutory disclosures, presumably because they place a higher weighting on the other audience groups. Many of these large companies deal with the reluctance of auditors to sign-off on governance disclosures by tagging those sections with a “nonaudited” heading. This reflects the fact that audit frameworks typically struggle to deal with nonstandardised disclosure, which makes sense given their primary compliance purpose (we have an alternative solution, below).

Unfortunately, the accounting standards and statutory requirements are in fact counter-productive for everyone except the Compliance Audience:

  • The bonus “paid during the reporting period” relates to performance in the prior year, which is generally irrelevant (though a lot of auditors are flexible on this one, allowing clients to show the amount paid after the period ended which is what everyone is interested in),
  • AASB2 is illogical for communication purposes and doesn’t tell anyone how much equity-based remuneration a person got:
    • In the case of equity with a service condition, the costs are spread out over all the years of the service condition, so you never see a whole equity grant.
    • In the case of equity with non-market conditions, entries may be negative and added to other years, producing an irrational aggregated reporting number.
  • Nowhere in the accounting standards is there a methodology to address “Realised remuneration” or “Target/Planned” remuneration packages, which are of key interest to many audience members.

For these, and other reasons, most stakeholders agree that statutory disclosure requirements and auditable numbers are insufficient to achieve any purposes of the Remuneration Report except those attributed to the Compliance Audience. Fortunately, there are usually extensive and robust processes in place to ensure this bare-minimum audience is satisfied and therefore, improvements can be focussed on for the other audiences that the report is mainly aimed for.

The audiences that gained most prominence in recent years are the institutional investors and proxy advisors. They are sometimes seen by companies as combative and impossible to please, however, their disclosure guidelines are generally more logical than statutory requirements, and they are generally happy to meet to gain a better understanding of the reason for a company’s practices or discuss issues with the aim of a better outcome for all stakeholders. Together, these groups arguably have the greatest influence on voting patterns for Remuneration Report resolutions at AGMs, however, the preferences of this group are often considered secondary to the Compliance Audience. Since these types of additional disclosures are not limited to statutory requirements, they include what the ASXCGCP&R4 appears to refer to as “governance disclosures” – not necessarily required by statute, but good governance. This is where most remuneration reports could benefit from some simple improvements that would please the majority of stakeholders, vote holders and improve voting outcomes. You can achieve this by reading the guidelines released by proxy advisors and institutional investors, meeting with them, and seeking advice from specialists on how to improve your governance disclosures.

The audience that is often given a low weighting in report preparation, but which is often the loudest at AGMs is the retail shareholder group. This is also the audience that the media tends to side with and shares the perspective of. While you may download guidelines from and meet with the ASA, creating improvements for general retail shareholders is often about presenting a concise and often visual overview of key aspects of remuneration, in plain English. Think of it as an executive summary, usually best served up-front, so that retail audiences do not have to wade through compliance material to get what they want.

Audiences we have not mentioned are the major private shareholder audience, which are typically closely connected to the Board and need less attention in the Remuneration Report, and activist groups who often fall into one or another of the three audience groups depending on their nature.

Optimising the Remuneration Report by balancing efforts will depend on the circumstances in each year: Has there been misalignment with institutional guidelines that needs to be explained in order for strike risks to be managed? What were proxy advisors saying last year and what were the comments at the AGM? Was there a strike (special disclosure requirements apply)? Are retail shareholders complaining about complexity? Can you improve shareholder support for the Remuneration Report resolution or is the Company happy as long as a strike is not received (a risky strategy as soon as something unexpected happens)?

What About KMP Definitions?

Oddly, the Corporations Act does refer to AASB 124 to define Key Management Personnel, which is the group that must be disclosed in a Remuneration Report. They are “those people having authority and responsibility for planning, directing, and controlling the activities of an entity, either directly or indirectly”. As well as directors, internationally it is often recognised that this “indirectly” term includes most direct reports to a President, MD or CEO (e.g. “Head Of”, “Vice President” or “Chief” type roles) or all members of the executive leadership team that together make decisions about the direction of the Company. Unfortunately, Australian auditors often appear to encourage companies to take a narrow view of this, and in extreme cases some Companies are only focussing on the MD/CEO and CFO. In the modern era, it is notable that IT and HR are often not seen as sufficiently influential, despite having a major and strategic impact across the whole business. In fact, the number of disclosed executive KMP in Australia has been shrinking over recent years, which can be expected to attract criticism from those audiences with an interest in transparency and completeness, if not from compliance regulators. For further detail refer to GRG Remuneration Insight 85.

Who is Doing it Well?

Each year GRG process about 1,000 ASX Annual Reports and our analysts rate each report based on statutory accuracy, transparency, clarity and completeness. The 2018 reporting period best rated reports as assessed by our analysts are (we excluded all GRG clients to ensure a fair listing):

  1. BHP Group Ltd
  2. REA Group Ltd
  3. South32 Ltd
  4. Woolworths Group Ltd
  5. CSL Ltd

This is Bloating Remuneration Reports; how do we Streamline?

Remuneration Reports have become more and more bloated since the “Two Strikes” rule came into effect, and the practice of making governance disclosures in addition to statutory disclosures has become best-practice. It is not uncommon to see a 30 page report which is a jumble of carefully branded graphics, statutory disclosures and governance disclosures aimed at satisfying all of the key audiences.

This is where the ASXCGCP&R4 can help: it recommends that Companies consider making more of its governance disclosures online, on its website and “incorporating by reference” into the Annual Report. GRG advocates the development of a Remuneration Governance Portal, which can contain the detailed explanations and technicalities that the institutional and proxy advisor audience wants, without cluttering up the Remuneration Report, and can be incorporated by reference (e.g. providing a written web link, or even a “QR” code that most modern devices can pick up to link to the website). The published Remuneration Report can then focus on giving retail shareholders what they need upfront and then addressing the Compliance Audience, reducing the number of sections in the Remuneration Report titled “Not Audited” (a common response to managing the tensions at present).

You can see some great examples of ASX listed Companies already doing this sort of thing, such as:

  • www.iress.com/au/company/corporate-governance/performance-schemes/ This is a fantastic example of providing a high level of detail on variable remuneration that would appeal to some audiences, online in separate documents through a dedicated portal, while keeping the Remuneration Report free of such detail,
  • www.healius.com.au/about-us/corporate-governance/ Here the Company has provided an excellent series of separate documents addressing different and technical aspects of KMP remuneration governance overall, with the Remuneration Report containing a summary and reference, and
  • www.cochlear.com/intl/about/investor/corporate-governance/company-policies Here the Company has provided a comprehensive single/integrated PDF document (see “Remuneration Policy”) addressing many detailed aspects of the KMP remuneration governance framework, including key variable remuneration terms and treatment. GRG can provide more examples upon request, as this appears to be a growing and sensible trend.

What Are the Other Hot Topics/Trends in Remuneration Report Writing?

  • 78% of the ASX 50 presented a “planned” or “Target” remuneration chart or table, showing what the Board’s intention was if expectations were to be delivered, i.e. the package that Participants expect to receive, against which outcomes can be compared, to assess appropriateness,
  • 82% of the ASX 50 presented a “Realised Remuneration” table, showing the fixed pay (typically the same as in the statutory and planned tables) plus the actual short term variable award outcome for the reporting period (and paid after it is completed) and long term variable vesting for the measurement period that ended with the reporting period, and vested immediately after (often showing the grant value, and the market value at the time of vesting),
  • 92% of the ASX 50 presented performance assessment outcomes for both STVR KPIs and LTVR vesting conditions, showing the link between performance and reward, so the rigour of variable remuneration frameworks can be judged, and
  • Despite this disclosure by the large companies, the most common complaint from audiences remains short term award condition disclosure.

Please do not hesitate to contact GRG for further discussion on any of these issues as they may relate to your business, drawing on our significant experience with these matters.