Investor insight: remuneration reporting
Paul Lee, head of corporate governance at Aberdeen Asset Management, talks to MerchantCantos about his thoughts on today’s remuneration reports
In the first in a series of interviews with investors and senior IROs, we asked Paul Lee to give us his thoughts on the challenging subject of executive remuneration reporting.
Frustrating is the first word that comes to mind. I would give them 2 out of 10, at best. It’s viewed as a compliance document rather than a communication opportunity. There are a handful of things that an investor really wants to get out of the report. As things stand, you basically have to plough through 25-pages of guff to find what just a few pages of valuable content. So there needs to be a shift in mind-set; a shift towards communication, not just compliance.
What do remuneration reports do well?I’m a fan of the requirement for a letter or statement fr om the remuneration committee chair. When it’s done well, it is worth reading fr om beginning to end. I see it as an opportunity for the remuneration committee to give us confidence that they have thought through the key issues, that they’ve addressed them sensibly and coherently, and that they have approached any challenges wisely.
What do I expect from a committee chair’s letter? Two pages at most. ‘These are the key issues that we faced; these are the key decisions that we made.’ Keep it simple and to the point.
If you were in charge of remuneration reporting, how would you structure your report?
Four pages. That’s all you need. The first two would be the remuneration committee chair’s letter. The next two would set out the four building blocks of a remuneration package that investors assess when deciding how to vote.
I would then provide the rest of the information that is required by legislation – information that will give investors confidence that they are not being misled by the upfront summary.
As an aside, I would add that the remuneration report must not be seen as an island. It needs to be coherently part of the overall report, clearly linked with the metrics used to monitor performance and the strategic report. In essence, the strategic report should provide the key elements that run throughout the annual report – including the remuneration report – like a stick of rock.
What are those four building blocks that you look for in each report?
- Salary. How much, and has there been any increase?
In terms of quantum, quite frankly, I don't see any difference between salary and pension. No senior executive actually gets a pension any more. It’s just cash. So why should we pretend otherwise? And I strongly believe that any increase in salary should be justified. There is no reason why an executive on a £1m salary should expect an inflation-adjusted pay increase every year – particularly as any small increment is rapidly geared into a bigger increase through the bonus and long-term awards, which are based on multiples of salary. So explain to shareholders why you think a salary should go up.
Investors need to know the metrics that were set at the start of the year, and why those metrics are the right ones. This is wh ere that linkage to the strategic report and the main KPIs is so important. We want to understand performance against those metrics over the period, and then see an assessment of the outcome of the bonus process, including an assertion from the committee that, in their judgement, the declared bonus is sensible.
- Long-term schemes.
These are similar to the bonus disclosures, and again that linkage to the strategy and KPIs needs to be made explicit. Whatperformance metrics were set at the start of the period? What’s the outcome? And again, we want something that tells investors that, given the performance seen in the round, the committee is happy that with that outcome. Seeing performance in the round is important, and we expect companies to draw in their understanding of softer measures of performance and delivery (such as health and safety wh ere relevant) as well as just making a mechanical assessment.
This is the bit that nobody does currently but that is really important. Investors want to see how the executive team’s ongoing shareholdings have impacted their wealth over the last three or five years. In many ways, this is the simplest and most important element of aligning their interests with shareholder
Why is a disclosure about executive wealth so important to you?
You can’t think about pay at the top level without thinking about wealth.
One of the things I find frustrating is when companies say that they need to increase pay and incentives because of the performance of the company. ‘We’ve done really well and need to recognise that in the long-term scheme and in the bonus’. Wouldn’t it be better for individuals to be recompensed through a long-term shareholding in the company – for their interests to be aligned with ours?
I think people might be a bit scared about disclosing ‘wealth’ simply because these could be big numbers. But to an investor, knowing that the interests of the executive team are aligned with those of their shareholders is critically important – this should be one of the biggest drivers of the management mindset that we all need to encourage long-term value creation.
What about the remuneration policy?
I think you can bed quite a lot of the policy into the four-page summary that I have proposed. It can be discussed in the committee chair’s letter and referenced at the start of each of the four building blocks of remuneration that are covered over the next two pages.
By doing this, you can get away from any thought that a company has to reproduce the entire policy each year. Instead, I suggest you park the full policy on the website and provide clear signposts to the document from the chair’s letter.
Of course, if the policy is changing then that should not be hidden on some website page – indeed it will, of course, feature heavily in the committee chair’s letter, because these will be among the key decisions that the committee has taken over the year.
Are you a fan of the disclosure of pay ratios?
Yes, we are. The ratio of CEO pay to average pay is interesting. No two business models are alike. So investors won’t be able to compare average pay ratios across companies, even within a single sector. But it will be interesting to see how the number changes at a single company over time.
There has been some debate about how average pay should be calculated – whether it should be the median or mean. Although the median does give you a marginally different perspective, frankly, I think the mean – which is typically much, much easier to calculate – is good enough.
But as well as the ratio to average pay, we also ask that companies report the ratio of the Chief Executive’s pay to that of his or her executive committee. This will give some insight into succession planning. It also gives an indication of the remuneration committee’s attitude to the Chief Executive – the extent to which they follow a ‘first among equals’ approach. And this is a number that would provide interesting comparisons across companies.
Any final thoughts?
It's a decision, isn’t it? The decision is whether you allow yourself to be tied down by rules and regulations or whether you make communication your priority. It’s not that you ignore the legislation – far from it. But there are more thoughtful and imaginative ways of delivering on the requirements. I would love to see companies cut through the red tape and put communicating with their shareholders at the heart of their remuneration report, just as they should in all reporting.
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