Government involvement in executive remuneration will have unintended consequences, says Laurence Grubb, Executive Committee Member at the South African Reward Association (SARA) and Managing Director at Khokhela Consulting.

Executive pay is a perennial hot topic in today’s media, particularly in the context of growing inequality. Unsurprisingly, it has found its way into governance codes like the King Report. There is even talk of governments getting involved in regulating executive pay, presumably in the interests of social cohesion. Whatever the reason, government involvement in what is a private, corporate matter should be vigorously resisted; shareholders have invested their money in a company and it is they who should be controlling how its executives are rewarded, and thus incentivised to perform. 

In cases where governments have attempted to intervene they have backfired. In the wake of the 2008 financial crisis, the European Union imposed a cap on bonuses for bankers. Banks simply increased the guaranteed pay and/or created a new category of variable pay called an “allowance” rather than a “bonus”. This has negatively affected the desired link between performance and reward.

Indeed, corporate governance codes and practices are leading to better solutions to the challenge. While they are perhaps not yet perfect—and may perhaps never be—considerable progress is being made as the business world builds up experience in this area. 

At the outset, it is perhaps worth noting that the common view that all executives are overpaid is simply not true. In fact, many remuneration committees are creating and implementing good remuneration policies which consider all stakeholders. Companies are in business to make a profit, so overpaying executives is hardly likely to appeal to them. 

So what are the current developments in corporate governance aimed at refining remuneration? And what are the issues?

Perhaps the biggest trend—evident in King III and judging from the draft in the King IV™ Report on Corporate Governance for South Africa 2016 issued by the Institute of Directors Southern Africa—is the concept of a shareholder vote on both the remuneration policy and its implementation. There are many variations. In Australia, for example, if a corporate remuneration policy receives a lower-than-75-percent vote at three consecutive AGMs, the board is forced to resign. The most common pattern is for the remuneration policy to be subject to a vote at intervals (two- or three-year intervals are common), with the implementation of the policy the subject of an annual vote. 

Obviously, it is impossible for the implementation vote to be binding—in the very nature of things, employment contracts cannot be delayed until the AGM. However, the question of whether the vote on the remuneration policy should be binding or not remains moot. The King approach has been to make it non-binding, but to make it a requirement for companies to “engage with” those who voted against the policy. 

It might seem that a binding vote on the remuneration policy makes sense, but there is always the risk that a group of minority shareholders could use the vote to further another agenda by effectively expressing a lack of confidence in the board. It may also not necessarily be an effective way to curb excessive executive pay: Switzerland has such a binding vote on remuneration policy, but its CEOs are the best-paid in Europe.

While we do not yet know what the final recommendations of the King IV™ Report, due to be released by the Institute of Directors in Southern Africa on 1 November 2016, will be, it seems certain that South Africa will remain loyal to the principle of a non-binding vote on remuneration policy, probably every two years, but with an obligation to deal with shareholder concerns. On balance, this seems sensible because it keeps the door open to a negotiated solution.

To conclude though, one must highlight a potential issue when it comes to the effectiveness of shareholder voting on such important issues. This is that the bulk of shareholder votes are controlled by third parties, the huge institutions who invest on behalf of individuals. They are often short of resources that are required to analyse policy issues carefully, and they are also not directly concerned with the company in the way that the original type of shareholder was. The original link between the provider of the funds, the board as an agent for the funder and the executives has therefore stretched to the point where some creative thinking is required to bridge this gap. 

This caveat aside, governance standards built on consensus and best practice are most likely to yield results, while regulatory intervention will simply be counterproductive.

ENDS
​
MEDIA CONTACT: Cathlen Fourie, 082 222 9198, [email protected], www.atthatpoint.co.za  

For more information on SARA please visit:
Website: www.sara.co.za  
Twitter: @SA_reward
LinkedIn: South African Reward Association
Facebook: SARA – South African Reward Association ​​​​​​​​​

Executive pay is a trigger for many media commentators and shareholder activists, but the truth is that remuneration committees (Remcos) have developed several methodologies for tackling what is a very challenging issue. Three main methodologies are used in South Africa where, in general, remuneration governance is on a par with global standards thanks to widespread adoption of the King Codes of Corporate Governance issued by the Institute of Directors in Southern Africa.
 
Each method has its own strengths and weaknesses, and reward professionals need to understand them thoroughly in order to make the right choices—particularly as the practice of naming the consultant used by the Remco is gaining traction. It is also worth emphasising that these methodologies are not watertight categories, and reward professionals will typically use elements of more than one methodology to arrive at a recommendation.
 
Market benchmarking
This is by far the most commonly used methodology in South Africa, and has the benefit of being easy to understand and of making intuitive sense. As the name implies, its basic principle is to establish what the CEOs of companies of similar size and complexity are being paid, and to use that figure as the basis for negotiation.
 
In this case, size is important because the job description of the CEO of an international bank will look very similar to that of the CEO of a four-store chain of hardware shops; the difficulty and impact of the respective jobs is clearly related to the relative size and influence of the two companies.
 
Various metrics are used to establish company size, but the most common, and most reliable, are turnover or revenue; nett profit before tax; number of employees and annual salary bill.
 
Other criteria are market capitalisation, geographic footprint and assets. Depending on the particular circumstances, there might be a case for including these last mentioned criteria, but with care. For example, the relative size of asset bases can give a very misleading picture of the difficulty of the CEO’s job. Thus, a company that owns a large amount of fixed infrastructure, such as a road or rail network, might be as large or larger than a multinational financial services company in terms of asset base —but running the latter is a much tougher job than the former, and the potential for loss is much higher.
 
This last point leads onto what is the major drawback of this methodology: it is something of a blunt instrument. Company size says a lot about the complexity and difficulty of the CEO’s job, but not everything. It should thus not be used uncritically.
 
Competitor model
This model also uses peer companies as the basis for setting the parameters of the discussion, and thus the first step has to be identifying suitable companies. The benchmarking methodology described above will obviously be helpful in this regard.
 
Having determined the right companies for comparison, this methodology compares the relative performance of the companies. Thus, a company that performs in the top quartile as compared with its competitors will pay its executives more than those of a similar company in a lower quartile of performers.
 
Obviously, company performance varies dramatically, so this methodology is perhaps most useful when used to determine the performance-related (variable) portion of the executive’s compensation package. Following a mixed model, then, benchmarking might be used to set the executive’s basic salary, while the competitor model forms the basis for establishing his or her incentives and share options.
 
Job-Sizing
This methodology is much more complex than the preceding two, and attempts to enable the reward professional to categorise the executive’s job more finely, and correlate it more closely to the rest of the market, using salary survey data. Many consultants have developed their own versions of this approach—this description will thus be as general as possible in order to identify the principles.
 
Based on research and experience, the methodology establishes the key criteria for evaluating executive positions. My own methodology, Execu-Measure, uses company size, the strategic level of the job, its impact, and its complexity and/ or requirement for problem-solving.
 
The process begins with establishing the magnitude of the job using company size. The criteria would typically correspond to the four listed in the benchmarking model above; the Execu-Measure methodology uses one of the following: number of employees, total assets or total equity/ liabilities.
 
The company sizing is the most heavily weighted factor. Once it is established, it is refined using a granular evaluation of the job itself. Execu-Measure uses three main categories, each with several sub-categories:

1. Impact of the job (direct, joint or indirect);
2. Strategic level, or freedom to act. This looks at whether the job is strategic across the whole group or at business-unit/ company level, as well as execution responsibilities; and
3. Freedom to think in the context of freedom to act. Here, the various categories are a freedom that is abstractly defined, broadly defined or well-defined. 

​All of these factors are weighted and values put into a large matrix, so that a particular job’s metrics can be cross-referenced to a single job level. The job levels correlate to those used in the various salary surveys.Thinking carefully through the methodology that is used is critical because the remuneration policy and implementation need to be defensible. It should further be noted that because there are so many factors involved, as well as the need to exercise judgement, that no formula can simply be applied. At the same time, Remcos and reward professionals should be aware that the executives will, of course, be advocating metrics and criteria that would favour higher rewards for themselves. Remuneration policies and strategies need to be robust.
 
The following guiding principles should inform the remuneration strategy and its implementation:

1. Tie pay as directly as possible to performance and value delivered to the company;
2. Use market norms as much as possible, they are a valuable benchmark. However, as noted above, it is necessary to think deeply about what market norms to use in the context of the company’s business; and
3. Impeccable governance is absolutely essential. 

It is always going to be difficult to get remuneration right, and it is unlikely that everybody will be satisfied. But with the right degree of care and thought, the reward professional can craft something that is fair, that can be defended and that, most important of all, supports the company’s strategic goals.

ENDS
​
MEDIA CONTACT: Cathlen Fourie, 082 222 9198, [email protected], www.atthatpoint.co.za  

For more information on SARA please visit:
Website: www.sara.co.za  
Twitter: @SA_reward
LinkedIn: South African Reward Association
Facebook: SARA – South African Reward Association ​​​​​​​​​

Executive pay is a hot topic for shareholder and stakeholder activists, but nothing gets everybody’s blood pumping faster than a CEO who walks away from a disastrous performance with a substantial golden parachute. “Companies need to reconsider the way they handle CEO terminations to avoid arousing controversy and appearing to pay for failure,” says Martin Hopkins, Executive Committee Member at the South African Reward Association (SARA) and a partner at PWC in the People & Organisation practice.
 
For example, in 2011, executives at Hewlett-Packard, Bank of New York Mellon, Burger King and Yahoo were asked to step down and received a combined $60 million in severance packages. Hewlett-Packard’s Leo Apotheker alone received a whopping $13.2 million in cash and stock severance.  Recently, a prominent South African company paid its CEO a golden handshake in excess of R20 million following a disastrous event on his watch .
 
“We must recognise that there may be sound commercial reasons why companies take the pragmatic course of essentially paying a CEO to leave, but it is not recommended from a governance point of view because it sends the wrong message to staff and shareholders, and severs the vital link between pay and performance,” Hopkins says.
 
Principles 161 to 163 of King III make it clear that an executive who is terminated because of poor performance should suffer financial consequences in order to support a “balanced and fair remuneration policy”. Based on its draft, King IV, due to be released by the Institute of Directors in Southern Africa on 1 November 2016, will take a similar line.
 
Well-defined process required to dismiss CEO for non-performance
It is important to recognise that the issue of CEO termination pay-outs is not necessarily as clear-cut as it may initially seem. One factor to consider is that South African labour law is extremely employee-friendly; dismissing a CEO for non-performance would require a proper process to be followed. It is likely to take between one and two years to dismiss a CEO, during which time the company would be disadvantaged by having no proper leadership.
 
“It’s a process that would necessarily involve lawyers and intense media scrutiny with all the reputational and other risks that implies,” Hopkins says. “You can see why it would make business sense to shut that particular circus down, and avoid a prolonged, public washing of dirty corporate linen.”
 
Legal factors to consider
Another factor is that CEOs who are dismissed would in any event be entitled to substantial pay-outs in terms of the law. A termination package would at a minimum include notice pay, and CEO notice periods are longer than those for lesser employees—six months is best practice—plus two weeks’ salary for every year worked. Share awards that have not yet vested would also be paid out on a pro-rated basis.
 
Frequently, the notice pay would be subsumed within a “loss-of-office” payment which, while not mandated, is generally considered reasonable. Hopkins says that around one year’s salary is considered acceptable.
 
“In other words, a CEO who is being dismissed or asked to leave would anyway be leaving with a substantial sum of money based on perfectly legitimate grounds. But what must be avoided is any implication that executives are not subject to the same strictures as other employees, who are penalised for poor performance. Such perceptions damage the notion that the company is run fairly, and break down the trust that is essential for sustainable profitability. It also means that successful executives who are moving on prematurely for other reasons, are by implication tarred with the same brush.
 
“All employees, including CEOs, need to be treated fairly but it may be time for companies to bite the bullet and go through due legal disciplinary processes leading to dismissal in the case of poor performance of senior executives,” Hopkins concludes.

ENDS
​
MEDIA CONTACT: Cathlen Fourie, 082 222 9198, [email protected], www.atthatpoint.co.za  

For more information on SARA please visit:
Website: www.sara.co.za  
Twitter: @SA_reward
LinkedIn: South African Reward Association
Facebook: SARA – South African Reward Association ​​​​​​​​​