By Cédric Laverie – Head of Corporate Governance at Amundi Asset Management
2016 was labelled as a shareholder spring – with high-profile cases of shareholder revolt over executive pay in numerous countries, such as BP in the UK, Renault in France and Deutsche Bank in Germany. 2017 appears to be in the same vein – its first casualty being Imperial Brand, which had to withdraw its new remuneration policy due to shareholders’ opposition.
Our dialogues with companies to prepare for the 2017 proxy season are also very focussed on remuneration issues and you can feel some anxiety from issuers. Some of it may be due to the specific nature of 2017 with the renewal of remuneration policies in the UK or the implementation of the Sapin II law in France and its double ex-ante/ex-post binding vote. But that anxiety also comes from the multiple and, sometimes, contradictory demands that issuers can receive from shareholders.
The Renault case in 2016 is especially interesting as it had to face multiple criticisms on very different aspects of its pay package. The French State was expecting a substantial decrease of remuneration (around 30%) from companies where it had a minority holding. Some shareholders were concerned by the quantum of Carlos Gohsn‘s total pay in his dual roles at both Renault and Nissan. Other shareholders were concerned at the lack of transparency of the Nissan package as Renault, despite owning more than 40 per cent of Nissan, considers it is not legally controlling it and so does not have to follow the French requirements on remuneration disclosure. Another group of shareholders, in line with Institutional Shareholder Services research, were concerned by the limited transparency of the deferred part of the bonus. And, a final group of investors were preoccupied with the challenging aspects of the criteria of the long-term plans where 80 per cent of the incentive could vest for performance below the peer group or under the budget. And probably some other investors also criticised other aspects of the remuneration, such as length of vesting period, weight of non-financial criteria (too much or not enough), balance between fixed, short-term and long-term parts, etc.
The board tried to react to that situation, even before the meeting where the say-on-pay was finally rejected. They strengthened the vesting scale of the long-term plan, once before the AGM and once after it, in order to remove payments for underperformance. They reduced the target short-term incentive (STI) from 150 to 120 per cent (but not the maximum of 180 per cent), removed the performance criteria under the deferred part and announced that the CEO would donate €1million of his variable remuneration to projects financed by a foundation. Recently, Nissan announced that Ghosn has just stepped down as CEO of Nissan, probably solving the issue of the double remuneration. Each board reaction seems to try to tackle the previous criticism and I must admit that most of them, taken separately, represent an improvement on a specific aspect of the remuneration. But as a whole, is that new remuneration package better or more aligned with the long-term development of the company? Are scattered decisions taken by different actors consistent?
Pay for performance
“Investors have been tasked with the impossible mission of reigning in executive pay as politicians were not willing to enter that sensitive arena”
Investors have been tasked with the impossible mission of reigning in executive pay as politicians were not willing to enter that sensitive arena. Some investors are not endorsing that responsibility as often illustrated by their proxy voting records but others are taking that duty seriously. In order to assess remunerations, investors have established policies and guidelines. Pay for performance (P4P) is one of the most common. On the face of it, it appears to be a good principle but the implementation is more complicated. First, performance is plural, can be assessed on multiple approaches and is very linked to the sector and strategy of the company. Unfortunately, a narrow vision of performance seems to have been often chosen by issuers and investors with the Total Shareholder Return (TSR). Relative TSR has the advantage of being transparent, not commercially sensitive, aligning remuneration with the experience of investors and quite binary when you have to build a vesting scale. Those advantages, combined with the P4P model of a leading proxy advisor, the Dodd-Frank approach to pay for performance and the temptation for both investors and issuers to opt for the easy solution has led to an excessive use of TSR. Investors are realising that pitfall.
The Executive Remuneration Working Group in the UK recently concluded that ‘the market needs to move away from a one-size-fits-all approach to a system where companies have more flexibility to choose the remuneration structure that is most appropriate for their business’. The latest ISS survey revealed that 79 per cent of its clients wanted to introduce other financial criteria in the P4P assessment beyond TSR. Hermes Investment Management in its latest document on remuneration principles stated that ‘executives should be incentivised to deliver strategic goals (as opposed to TSR) and be mindful of the company’s impact on key stakeholders’.
Being too prescriptive can lead to unintended consequences or simplistic implementation of our recommendations. But, as the public debate on remuneration continues and as investors are becoming more and more sophisticated, deepening their analysis and trying to find solutions, several new recommendations/ideas on remunerations have been expressed by investors, but can we build the prefect remuneration with them?
Hermes suggests merging short-term and long-term incentive schemes and implementing a simpler structure by reintegrating the ‘always paid’ part of the variable remuneration into fixed but with a 50 per cent discount. The Executive Remuneration Working Group suggests a new approach by transferring performance-based long-term incentive plans (LTIPs) to restricted shares with a discount rate (Weir plc partially tried to implement that idea but got its remuneration report rejected). Some investors, such as ERAFP or Ircantec in France, have established ‘maximum socially tolerable’ ceilings for pay, either with reference to local minimal wages or to the median pay inside the issuer. Mirova is opposing resolutions on remuneration if it does not integrate environmental and social performance metrics, Fidelity is voting against companies that do not have minimum five-year retention periods on performance share awards and many others have found specific criteria to improve executive compensation.
Such recommendations and guidelines are nearly always valuable to tackle specific issues of remunerations but we cannot avoid the possibility that some are not compatible, some cannot be stacked together or some cannot be adequate to every situation faced by a company. It is sometimes disconcerting to hear companies justifying changes in some part of their remuneration policy by following the practices recommended by some investors or proxy advisors without much concern about how it fits with the rest of the package and the strategy of the company.
Our duty as shareholders is to monitor companies and hold boards accountable to ensure the long-term success of investee companies. As we are not part of the companies and only one stakeholder among others, we must not try to micromanage. I totally agree with the conclusions of the Executive Remuneration Working Group that the board and its remuneration committee should be fully accountable for the remuneration with the flexibility to choose the most adequate structure and the necessary discretion to adapt its outcomes. Nevertheless, while we must be confident in its ability to do it properly, we must monitor the output and vote accordingly in the numerous countries where shareholders have a say on remunerations and when we must renew the members of the remuneration committee. Prescriptive guidelines and policies and self-centered principles of ‘pay for (market) performance’ or ‘alignment with shareholders (only) interest’ seem to have failed previously, so we, the investors, must find a new, more holistic framework to assess the quality of the proposals submitted by companies and to guide our dialogues with boards on that issue.
I realised that this need for a holistic approach on strategy, value creation over time and accountability to stakeholders resonated with another objective in which we are involved: integrated thinking and integrated reporting. So how would the integrated reporting framework apply to remuneration? Here are the seven guiding principles developed by the International Integrated Reporting Council (IIRC) for its international reporting (IR)framework and how it could fit our remuneration conundrum:
Strategic focus and future orientation This covers the alignment of the remuneration with the company’s strategy, and even its purpose and culture, to the long-term horizon to the company. The choice of the types of performance metrics (financial, extra-financial, qualitative), balance of fixed, short-term and long-term parts and length of holding period are part of that principle.
Connectivity of information This principle is more about the fine-tuning of remuneration to fit challenges in the implementation of the strategy. The dynamic in setting performance criteria and targets, vesting scales and the discretion of the committee are part of that principle.
Stakeholder relationship The remuneration policy should take into account and respond to the interests of stakeholders. Engagement with shareholders, employee representatives in remuneration committees, stakeholder advisory panels or consultation/communication with stakeholders on remuneration are part of that principle.
Materiality The remuneration report should disclose information about all the elements that affect the remuneration output. This principle can cover the question of transparency of the targets of the performance criteria, elements of benchmarking or pay ratio reporting to understand the setting of the remuneration.
Conciseness A remuneration policy should try to aim for the simplest structure necessary to reflect the first principle. Suppressing or merging incentive schemes when they are not fully relevant are part of the implementation of that principle.
Reliability and completeness Complete and balanced disclosure in remuneration reports is essential. When regulations are not sufficient to ensure these objectives, guidance on reporting established with stakeholders can be useful. In that aspect, the GC100 and Investor Group guidance is a good example, whereas the application guide for the Afep-Medef code seems less effective as it was developed by issuers alone without taking into account the needs of investors.
Consistency and comparability Consistency over time in presentation should allow stakeholders to understand more easily the evolution of the remuneration policy and how it fits the dynamic of the company’s strategy implementation. Guidance on reporting established with stakeholders can also be helpful for comparability.
My thoughts on using the integrated reporting framework for the issue of remuneration are quite recent and still superficial but I believe that this direction could create an interest from others, possibly leading to a deeper investigation of the idea.
As the process is centered on companies and their boards, it would require some integrated thinking to be done to implement but for those already producing integrated reports it would only be a short step. Several of those companies, especially in South Africa, are already approaching what could be an ‘integrated remuneration’ in their integrated reports. As investors, we can push that process through our engagement with companies by questioning their remuneration policies through the scope of the three first strategic principles (the four other being more operational).
This approach would be mutually beneficial as companies would get more flexibility in setting their remuneration structure and less contradictory demands from shareholders. Investors should benefit from a more comprehensive framework to understand how the remuneration fits the value creation process for the company and its stakeholders.
Finally, I just hope that this idea will not be another element contributing to making the actual conundrum even more intractable.
About the Author:
Cédric Lavérie is Head of Corporate Governance at Amundi Asset Management, a leading European asset manager with €1083 billion of assets under management worldwide (as of 31 December 2016). He is responsible for managing a dedicated team in charge of corporate governance issues, including shareholder dialogue and proxy voting. He is a member of the Corporate Governance Committee of the French Asset Management Association and the Shareholder Responsibilities Committee of the ICGN. Prior to this role, he worked as a corporate governance analyst at Credit Agricole Asset Management and AXA Investment Managers and in risk management at Paribas (Suisse) SA. He holds graduate degrees in Banking-Finance from Paris II University, International Economic Law from Paris X University and Politics from New York University.