Engagement with external stakeholders has become paramount, given the escalating societal demand for corporate purpose to deliver long-term value creation and sustainability. These engagements need to be conducted both before the writing of the remuneration report and after issuing the report to manage stakeholder relations and minimise surprises. An effective engagement strategy can maximise the chances of investors supporting your remuneration votes.
The following checklist serves as a guide for directors to assess their company’s purpose, strategy, and remuneration outcomes:
Caution regarding fixed pay increases
Shareholders may raise concerns when significant fixed pay increases are considered. While adjustments for CEOs and executives due to high inflation and salary increases for other employees can be understandable, it is crucial to provide justifications beyond mere inflation and performance. Shareholders, especially in South Africa, will want to understand if the fixed pay increases for executives align with increases throughout the company, addressing concerns about pay inequity.
Comparing executive remuneration to market rates
Gaining investor confidence requires a thorough comparison of executive remuneration to market rates. However, it is important to acknowledge that proxy advisors and other stakeholders may employ different evaluation methods. Therefore, be prepared to provide detailed explanations of how market relativity has been assessed. Utilising an independent benchmarking process can help determine an appropriate level of fixed pay for executives, considering South African market practices.
Consideration of total shareholder return (TSR)
TSR, as a measure of long-term value creation, holds significance for stakeholders. Arguments for significant fixed pay increases may not succeed if the company consistently underperforms in terms of TSR, even if executives have not received pay increases for several years.
It is important to strike a balance between addressing the need for competitive remuneration and ensuring long-term value creation and sustainability for the company and its stakeholders.
Addressing the risk of executive turnover
While there may be a risk of executive turnover, it is worth noting that one of the proxy advisors may not support substantial fixed pay increases, especially if the pay is significantly below median levels. Finding a balance between competitive remuneration and long-term value creation is crucial.
For example, let us consider a hypothetical South African company, ABC Corporation, which has recently experienced high inflation rates. To maintain market competitiveness and retain top talent, ABC Corporation’s board of directors believes it is necessary to provide a fixed pay increase to its CEO and executive team.
After conducting an extensive benchmarking exercise, ABC Corporation recognises the importance of TSR as a measure of long-term value creation. The company consistently monitors its TSR performance and focuses on implementing strategies that enhance shareholder value. The board acknowledges that significant fixed pay increases may not be well-received by shareholders if the TSR has been subpar, even if there are arguments that executives have not seen raises in previous years.
When making discretionary adjustments to incentive outcomes or granting retention remuneration, it is crucial to provide sound reasoning.
Recent instances where positive discretion was used to vest incentives during unexpected or uncontrollable cyclical downturns have not garnered favourable responses from investors or proxy advisors. Adjusting performance requirements by ”moving the goalposts’ is generally viewed unfavourably.
Retention grants are unlikely to receive broad support, especially when incentives have not been paid out. In a cyclical downturn, companies operating within the same economic cycle and experiencing non-payment of incentives are not likely to attract prospective employees who may have been disappointed with similar circumstances elsewhere. Proxy advisors and investors argue that there is minimal risk of executive flight in such a scenario.
Read:
Time for transparency on executive pay in South Africa
Pay executives more, not less?
To address investor concerns and demonstrate a commitment to sustainability, companies need to integrate meaningful and quantifiable non-financial performance measures. Proxy advisors emphasise the selection of measures critical to long-term success, focusing on value rather than values. If environmental, social and governance (ESG) measures are relevant to preserving or enhancing value, it is crucial to communicate this clearly through engagement and disclosures.
Targets based on outcomes
Remuneration frameworks that include job description measures are generally viewed unfavourably by investors and proxy advisors. These measures reward executives for tasks that should already be part of their responsibilities, and they can be seen as an easy way to inflate scorecard outcomes. It is essential to set targets based on outcomes rather than processes.
Investors increasingly want transparency on how a company’s ESG goals are integrated into the remuneration framework. While companies may disclose ambitious ESG targets, particularly related to climate action, without a clear link to remuneration, investors may question the legitimacy of these goals. There is concern that companies may engage in ‘greenwashing’, presenting a misleading image of their commitment to sustainability. Tying ESG goals to remuneration ex-ante rather than ex-post demonstrates to investors that these goals are genuinely supported and have tangible consequences.
Read:
What should remuneration committees be focusing on and why
Predicting the 2023 landscape for director, executive and general staff pay in SA
For instance, let us consider a South African energy company, PQR Energy, which recognises the significance of non-financial performance measures, particularly in the context of ESG considerations. To meet investor expectations, PQR Energy has proactively aligned its remuneration framework with its ESG goals, demonstrating a serious commitment to sustainability.
PQR Energy conducted a comprehensive materiality assessment to identify the ESG factors most relevant to its long-term success and value creation. Through stakeholder consultation and expert analysis, the company determined that mitigating climate change risks, reducing carbon emissions, and promoting community engagement are critical areas of focus.
In response, PQR Energy has directly integrated ESG goals into its remuneration framework. Executives’ performance evaluations and incentive outcomes are now linked to achieving specific targets related to carbon reduction, renewable energy investments, and community development initiatives.
By tying ESG goals to remuneration ex-ante, PQR Energy provides clear evidence to investors that these goals are substantiated and not mere words.
PQR Energy ensures transparent communication through comprehensive engagement and disclosures. The company shares detailed information about its ESG goals, the specific metrics used to assess performance, and the alignment of these goals with the overall remuneration strategy. Regular reporting demonstrates PQR Energy’s progress towards achieving its ESG targets and the positive impact it has on long-term value creation.
The company recognises that investors expect more than just financial results and are increasingly interested in understanding how environmental and social considerations are embedded within the company’s culture and operations.
Chris Blair is CEO at 21st Century.
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