In March, Glass Lewis noted that everything is affected by the coronavirus and outlined our approach to governance issues in the context of the pandemic.
The emergence of COVID-19 as the trigger for a global market downturn in 2020 has seen issuers frequently asking Glass Lewis two questions:
- What is shareholder appetite for the payment of executive bonuses for the past financial year?
- How should we be setting targets for short-term incentives (“STIs”) for the next financial year?
In this note, we provide some background and some answers in respect of Glass Lewis’ view, as investors shift their focus to the upcoming proxy seasons in Australia, New Zealand and India and other global AGMs scheduled for the second half of 2020 with remuneration proposals.
The first question arises from issuer uncertainty on how shareholders will react to executive pay, in knowledge that shareholders with broad portfolios have been hit hard by COVID, irrespective of whether the issuer at hand has proved to be resilient.
Some shareholders have also taken to publicly signalling that boards should be making “appropriate cuts” to pay considering the experience of shareholders, employees and the community at large. Boards have then been left to consider the question to what extent that general advice applies to their specific circumstance.
The second question arises from the continued uncertainty of how COVID-19 will impact the community, businesses and government actions and policy. It has been commonplace for companies to have withdrawn their market earnings guidance, and the same challenges in forecasting will apply to setting performance targets for management.
What is Glass Lewis’ approach to executive bonuses for the past financial year ?
What is reasonable for pay will ultimately vary by company specific circumstances and, as outlined in our March guidance on COVID-19 and our many other rapid policy responses in April, we will be taking a pragmatic approach to our voting recommendations. In order to best provide insight into how we will consider executive bonuses in the COVID-19 context, we consider four performance situations below.
- Performance has been devastated and the company’s prospects are now on life support.
In these circumstances we expect that nil or nominal bonus payments should be made in respect of performance of the last financial year. We have a low tolerance for the payment of bonuses when company prospects are brought to the brink and shareholder value is significantly impaired, even more so in the event employees have had pay reduced and jobs lost or furloughed.
However, special consideration can be made for forward-looking retention arrangements in this scenario. While backwards-looking performance pay is expected to be minimal, we acknowledge that innovative and nuanced remuneration structures will be valuable in keeping management both retained and incentivised to turn around the company’s prospects. Boards should take care to differentiate between these forward-looking retention arrangements and backwards-looking performance bonus outcomes to ensure transparency of their intentions.
Boards who implement such retention arrangements will need to justify the arrangements relative to the realistic employment prospects of executives in a badly impacted industry. Consideration should also be given to the reputational damage that could arise if the arrangements later result in windfall gains for executives should the company’s prospects improve over time as a result of improving conditions that lie outside of executive control.
- Performance has been moderately and negatively impacted.
We expect to see very limited STI bonus payments, if any, for executives in this category. For properly designed remuneration structures that are aligned with performance, financial metrics for these companies will not meet threshold resulting in lower overall payouts.
Companies that have implemented financial gateway conditions that have failed in the past financial year will have already designed remuneration structures that do not need the consideration of downward board discretion.
However, the boards of companies who have not introduced such a feature will need to consider the appropriateness of overall vesting outcomes where non-financial metrics result in sizeable payouts. The concept of pay-for-performance – with poor shareholder returns in mind – will be front and centre to our considerations of remuneration proposals.
We have a low appetite for STI bonuses in this scenario. Sizeable STI awards will need to be accompanied by strong justification to overcome the misalignment with pay-for-performance to avoid an against recommendation from Glass Lewis and shareholder protest votes.
- Performance has been modestly and negatively impacted, and the company has outperformed the market on a relative basis.
For companies that fall into this scenario, we expect well designed remuneration structures should lead to reasonable outcomes without significant board discretion.
Earnings-type metrics will likely fail to meet threshold achievement; however, this may be moderated with achievement under non-financial measures. Unlike scenario 2 described above, the overall outcome already moderated by lower financial performance is less likely to fail to meet pay-for-performance expectations.
Nonetheless, we do not expect any upward adjustments to pay for relative outperformance. Any upward adjustments in any of the described scenarios in this note will need to be properly justified as they will be scrutinised at the company’s shareholders meeting.
- Performance has been strong on an absolute and relative basis.
There are two sub-scenarios that fall under this category.
Defensive companies that remain resilient throughout the COVID-19 crisis can expect Glass Lewis to support relatively generous bonus outcomes where the remuneration structure had been set up to pay counter-cyclically. We intend to support fit-for-purpose remuneration structures throughout the cycle and believe that failure to do so throughout this challenging time will undermine the credibility of any non-bullish remuneration structure.
The other sub-scenario is companies that have received unexpected tail winds as a result of COVID-19. While we expect that such companies will likely be paying STI bonuses, we encourage boards to consider if COVID-19 has resulted in a windfall gain not reflective of the executive’s efforts, in which case bonuses may be pulled back from stretch or maximum levels. These companies are likely to face significant scrutiny, including in the media, as such outcomes risk topping the rankings of executive pay for the year. In these cases, downward discretion should to be considered if pay does not meet community or shareholder expectations.
A further consideration across the above scenarios is that of employee welfare. We expect that companies who have had to retrench employees as a result of diminished demand for goods and services will also reflect these diminished prospects in lower executive pay. Not only will this be considered an alignment of pay and company performance, this is also a matter of reputational management – boards and executives would do well to ensure they do not appear disconnected from their wider employee base during this difficult time, particularly in Australia where compulsory superannuation (pensions) means almost every employee in the economy is also a shareholder.
Companies that are undertaking planned retrenchments that are not due to diminished demand flowing from COVID-19 would do well to clearly distinguish themselves from the above group.
What is Glass Lewis’ view on target setting for executive bonuses for the next financial year?
Beyond what a company discloses publicly, shareholders and advisors are at a distinct disadvantage to consider target setting compared to boards or company insiders, and so we can only offer limited commentary on this question.
We acknowledge the difficulty in forecasting and will be supportive of action by the board to tackle this challenge. Such steps may include modifying the performance range between threshold and stretch, reducing the variability of pay with a corresponding reduction in quantum or changing the structure to account for a range of scenarios how COVID-19 may play out.
Boards who take such steps will need to excel at justifying and communicating such changes to ensure that the rationales for change is well understood by shareholders.
One caution to boards, should the outcome of any step be to ensure or significantly increase the probability of a given outcome, such as a fixed or target bonus outcome, we expect to see a corresponding decrease in quantum. As a point of reference, it is common practice for long-term incentives (“LTIs”) awards to lapse for below median performance, boards should therefore consider a reduction of more than 50% to the value of such awards should vesting be made certain.
As in any other year, Glass Lewis will support remuneration proposals that are in the interests of shareholders with a view to fair and reasonable outcomes to executives. The next financial year is expected to be a year in which remuneration structures will be challenged to lead to such outcomes based on precedent. We encourage boards to evaluate their own circumstances as well as market expectations in settling on overall remuneration outcomes for their executives, and to keep justification and disclosure front of mind when using board discretion.