Executive pay: focus on 'why'

Executive pay: focus on 'why'

Executive pay: focus on 'why'

  • 15 February 2013
  • Melbourne, Australia

This appeared as an Opinion Editorial in The Australian Financial Review, Thursday 17th January, 2013.

Tim Nice, Mercer’s leader for executive remuneration

A single figure that captures an executive’s annual pay makes sense, if it means shareholders spend less time puzzling over numbers and more time considering the rationale behind them.

BHP Billiton’s Geof Stapledon has suggested that slated changes to disclosure laws will increase confusion, and favours a simpler approach that reports just one figure.

Indeed, the proposed changes to the Corporations Act announced late last year would mean up to three figures must be reported in annual reports: past, present and future pay. This marks a change from the current regime, which does not outline specific rules about how remuneration for key management personnel should be disclosed.

However, more disclosure isn’t always a good thing. As we’ve seen with retail financial products, long Product Disclosure Statements (PDS) were intended to help buyers make decisions, but bamboozled them instead; hence the move towards the short-form PDS.

In the same way, reporting executive pay in even more detail has the potential to muddy the waters, whereas simpler disclosure would increase clarity for shareholders, companies and the market.

At the moment, even sophisticated shareholders and specialist proxy advisers can get bogged down in trying to decode a remuneration report. And not surprisingly, the media headlines on executive pay tend to capture the largest number that can be reported - none of which is helpful for investors or companies.

If we moved to reporting just one figure, the way it is calculated would be up for debate. For example, a single figure showing pay received in a given year should reflect base salary, annual bonuses paid, bonuses deferred from previous years, and long-term incentives which vested that year.

It’s worth noting that this definition of actual pay would strongly reflect past performance, particularly where long term incentives come into play. Grants from prior years would be linked to performance expectations at the time of the grant. So, will an investor be any wiser by knowing what was earned on the basis of a decision made three or four years prior? In some respects, this approach could understate potential pay, even though it reflects the actual outcome.

But greater transparency isn’t simply about having a ‘magic number’ to compare; it’s about greater access to information on how that number was reached. The ‘how’ is the secret to determining value for money.

The company needs to explain its approach to remuneration and whether it has achieved what was intended: Does it attract the best possible talent and reward high performance? Is it linked directly to the company strategy and approach to risk taking? How does the board make decisions on pay, and if discretion is exercised, when and how is this applied?

However, while boards are becoming more thoughtful about their pay philosophy there are no strict requirements for explaining how an executive’s paypacket has been designed, beyond basic governance requirements.

Such reporting has improved in the past couple of years, thanks to the ‘two-strikes’ rule and increased level of scrutiny it has created. However, there is still scope for improvement.

Meaningful disclosure would include sharing details about which peers the company benchmarks its pay against, and greater insight into performance hurdles for bonuses: why they were chosen, what weighting they have in the plan and if there’s a threshold below which no incentive is paid.

In reality, the one-figure approach would only work effectively if it were part of a broader move to shift the debate away from a sole focus on ‘how much’ to include more of a focus on ‘why’.

What’s considered a ‘reasonable’ paypacket will always be subject to debate. A regime that simplifies the way we report executive remuneration and provides more justification for how a figure is established, gives both companies and shareholders the opportunity to have a different - and more productive - conversation around pay.

About Mercer

Mercer is a global leader in talent, health, retirement and investments. Mercer helps clients around the world advance the health, wealth and performance of their most vital asset – their people. Mercer’s 20,000 employees are based in 43 countries and the firm operates in over 140 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), a global team of professional services companies offering clients advice and solutions in the areas of risk, strategy and human capital. With 55,000 employees worldwide and annual revenue exceeding $12 billion, Marsh & McLennan Companies is also the parent company of Marsh, a global leader in insurance broking and risk management; Guy Carpenter, a global leader in providing risk and reinsurance intermediary services; and Oliver Wyman, a global leader in management consulting. Follow Mercer on Twitter @MercerAU @MercerInsights