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“Now is the winter of our discontent”.
An analysis of ‘No’ votes and
how to avoid them!
Laurence Grubb 5 November 2015
The winter of our Discontent
“Now is the winter of our discontent
Made glorious summer by this son of York;
And all the clouds that low'r'd upon our house
In the deep bosom of the ocean buried.” ― William Shakespeare, Richard III
Now that we have understood the reasons for past failures, we are able to use this new found knowledge to our advantage.
By pre-empting shareholders apprehensions and proxy advisor concerns.
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An analysis of ‘No’ votes and how to avoid them!
Contents
Analysis of disclosures for Top 40 JSE listed Companies;
Case studies of JSE listed companies who received a significant ‘No’ vote from their shareholders on aspects of their remuneration policy and the implementation thereof;
The main “Themes of Discontent”, the results, implications and lessons learnt; and
A local and international view on remuneration policy disclosure requirements.
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Overview of Top 40 JSE listed Companies
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Top 40 JSE listed Companies
85% of companies provide details on the voting results for all resolutions:
• Of these companies, the average voting result was 90%
• 20% of these companies received a 80% vote or lower
10% of companies do not disclose the results of the voting, but release a statement with the final overall outcome i.e. all resolutions have been passed with majority vote.
5% of companies do not release any information on the outcomes of the voting results.
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JSE Listed Company Case Studies
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Overview of Case Studies
Study 1 Study 2 Study 3 Study 4
Industry Basic Materials
Industrial Property Financial
2014 Vote 64% 69% 64% 91%
2013 Vote 70% -* 78% 82%
2012 Vote 85% -* 80% 97%
Main Themes of Discontent
1. Performance Targets X X X
2. STI and/or LTI X X X X
3. Clawback Policy X X
4. Min. Shareholding Requirements
X X
* Passed with majority votes
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Case Study One
Shareholder discontent over the three year period:
Peer group for TSR benchmarking.
Incentive targets for both short- and long- term incentives.
100% of LTIs were not linked to company performance targets.
No clawback policy regarding incentives paid to key personnel.
Shareholders considered a share settled plan more appropriate than the existing option plan.
The minimum shareholding requirements for execs were not met.
Performance on long-term/large scale project performance not taken into account.
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Case Study Two
Shareholder discontent that resulted in a low voting percentage:
The level of discretion in relation to calculating the bonus paid to the CEO i.e. tenure based and not performance related.
Long-term incentives granted under the groups DBP (Deferred Bonus Plan) – This plan is targeted at retention only.
The performance metrics for the CSP (Conditional Share Plan) for the new CEO are not clearly disclosed.
Another concern raised by the proxy advisor was that the 10% share usage limit is higher than recommended practice, however no reasons for justification were provided.
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Case Study Three
Reasons why the company experienced a decrease (16%*) in shareholder votes:
Shareholders required justifiable reason as to why the comparator group was revised.
Detailed methodology on determining the comparator group needs to be justifiable and transparent.
A deferred STI was put in place of which 50% was paid in cash in year one with the remaining portion deferred over 4 – 7 years, no clear disclosure of performance targets and measures.
There were no obvious reasons for the policy to be voted against, however due to insufficient disclosure, this created an apprehensive view on the remuneration policy.
* over three years 10
Case Study Four
Shareholder discontent that resulted in a 15%* drop in shareholder votes:
The impact of global requirements led to a change in pay structures.
Companies have been warned against excessive variable pay for material risk takers.
Clawback policies need to be implemented and operational.
Introduction of an “annual allowance” in line with international practice to reduce the ratio of variable pay to fixed pay.
However this approach was not consistent with SA market practice.
* Between 2012 - 2013 11
Boards and Board Committees
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Main Themes of Discontent
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1. Performance Targets & Transparency in Disclosures
Key concerns were about the performance targets and personal performance measures.
Suggested Solution:
Actual targets and measures for all incentive schemes need to be clearly defined and disclosed.
They should align with the financials in the strategy and budgets.
Threshold should be achievable but require some effort. Should be achievable 75% of the time.
Target should be set so that significant effort is required. Should be achievable 50% of the time.
Stretch should be set at level at levels that require impressive effort. Should be achievable 15% to 25% of the time.
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2. Short- and Long-Term Incentive Schemes
Key concerns were about the design of the scheme.
Suggested Solution:
Ensure the design aligns with the company strategy and shareholder values.
Ensure that the design does indeed drive performance.
Ensure that the design encourages retention but not as a stand alone scheme with no performance requirements attached.
Ensure that the design is ‘funded’ by the additional performance required.
Vesting should not start at less than three years.
STI’s: Consider delaying the vesting of a portion for 3 to 4 years for retention purposes for key personnel/snr managers. 15
2. Short- and Long-Term Incentive Schemes (cont.)
Key concerns were about the criteria used to select the comparator group.
Suggested Solution:
Look at a number of factors such as:
Problem in South Africa is the limited number of companies from which to select! Need to explain reasons for the selection and number of companies selected.
Revenue Profit before Tax EBITDA Total number of employees Magnitude of operations Location of operations
Total assets Market Capitalisation Salary and Wage Bill Industry Reasons for shareholders
investing in the company
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3. Clawback Policy
Policy should include the detail of adequate procedures to claw back any or all bonuses should any of the following exist:
Misconduct
Misrepresentation
Malus
Clawbacks regarding over incentivising of key personnel should be published as part of the remuneration report.
VW to use bank-style clawback of CEO pay
Post VW’s CEO’s resignation, it was identified that 482,000 vehicles were rigged to cheat on emissions tests. However the CEO had received $17.8m making him one of the highest paid in Germany. VW may claw back some or all of his bonuses in respect of the above
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4. Minimum Shareholding Requirements (MSR)
Shareholders consider MSR as desirable for Exco as it reinforces their commitment to the success of the company by having ‘skin in the game’.
Example of how a company can assist with MSR?
Executive is encouraged to invest up to 50% of after-tax bonus into company shares. The company will in turn match it up to 150%.
Level Years Employed
% of Salary in Company Shares
Exco Members 3 years 75%
Exco Members 6 years 150%
Exec Directors 3 years 100%
Exec Directors 6 years 200% 18
5. Additional Suggestions
Lobbying
Proxy advisors
Shareholders
Key board members
Disclosure
Details of the scheme
Key performance areas (Personal)
Performance conditions (Company)
Payments for different levels of performance
Rules for employees exiting the company for various reasons.
Disclosure of the total value and not only the portion vesting.
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Shareholders
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Shareholder Guidelines
Compare policy to typical market practice and ensure alignment.
All incentives should be linked to performance.
“Golden handshakes / handcuffs” drive the wrong behaviours.
Overall pay mix in line with regulations and not too excessive.
Discretion not advised with regard to incentives.
No re-pricing of options.
Personal performance limited to 1/3 of variable pay, with company performance making up at least 2/3 of variable pay.
Non-executives should not receive incentives or fixed remuneration.
Proxy advisors are used as a first point of reference.
21
Shareholder Guidelines (cont.)
Shareholders employ analysts whose responsibility is to research the market and create and / or review guidelines.
Portfolio managers consult the analysts prior to making decisions.
Guidelines are company specific taking into account industry considerations and general market trends.
Shareholders do not operate under strict rules, but are rather governed by strong guidelines.
Peer comparisons should not drive remuneration as this leads to a constant upward spiral in remuneration.
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Proxy Advisors
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Avior Capital Markets
Relationship between non-executives and shareholders/advisors
There is a need for non-executives to engage with shareholders and other appropriate sources to ensure a common understanding on changes and requirements in the market.
Results and reports need to be released timeously to provide sufficient time to review and consult where necessary.
The intent behind changes and decisions needs to be clear, precise and transparent.
Companies should be engage with shareholders/advisors n changes to ensure decisions are not delayed due to lack of information/understanding or receive a no vote.
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Avior Capital Markets (cont.)
Policy decisions
Policy needs to be representative of what is in practice.
The relationship between performance and variable pay needs to be clear, transparent and implemented.
The remuneration mix needs to be appropriate.
Peer group must be representative of the company and consistent over a number of years.
Incentives that encourage retention but are performance driven are favoured.
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Investment Management Association (IMA)
Introduction of role based pay and/or allowances as part of Fixed Pay
This allowance is an element of pay provided to an employee by nature of the role and is not linked to performance.
IMA is not in favour of these payments.
Change in Remuneration
Executive increases should not be above inflation and/or the increases granted to the general workforce.
Any increase to the maximum variable pay needs to be clearly explained.
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Investment Management Association (IMA) (cont.)
STI / LTI Incentives
Threshold: the absolute amount paid to executives for threshold performance should be considered and not just the portion of the award vesting.
Length of performance: this should not be less than 3 years and linked to the company strategy.
Changes to performance conditions: No retrospective changes are supported and all incentive plans are to be cognisant of exchange rate risk.
Furthermore shareholders are not immune to exchange rate risk, therefore this is not reason enough for changing performance conditions at management level.
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Institutional Shareholder Services (ISS)
STI / LTI Incentives
Remco should not allow vesting of incentive awards for below median (comparator group) performance. (This is a tricky one!)
All exceptional awards should be clearly linked to performance and demonstrate shareholder value creation.
Incentives should be robust, with stretching performance targets to reward strong performance and drive shareholder value over time.
Incentive plans should not lead to excessive dilution.
Shareholder funds should not be used to grant financial assistance to directors, officers or related persons without a clearly disclosed and fully justified explanation.
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Institutional Shareholder Services (ISS) (cont.)
Committee Structures
At least 50% of the board members should be independent non-executive directors.
For controlled companies, the board should include at least 33% independent non-executive directors.
Should the chairperson not be independent, then a lead independent director should be appointed
(Also recommended by King III).
The audit committee should be fully independent .
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Boards and Board Committees (part 2)
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Summary of Proxy Advisor Principles
All proxy advisors have an overlap with regard to their approach. The following is an overview of these principles:
Well documented in respective policies.
Transparency and accountability.
Management interests should be aligned to shareholder values.
Clear disclosure of performance targets and measures.
All incentives to align to long-term shareholder value generation.
Short-term growth should not be rewarded at the expense of long-term value.
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Local and International Disclosure Requirements / Recommendations
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King III Recommendations on Disclosures
Directors Remuneration should be fair and responsible
Remuneration policies should create long-term value.
Annual bonuses linked to performance consistent with long-term value.
Long-term awards should be based on performance conditions measured over a period linked to the company’s strategic objectives.
No re-testing in subsequent periods.
Regular annual grants of awards is desirable.
Options “underwater” should not be re-priced, surrendered or re-granted.
No automatic waiving of performance conditions on change of control, capital restructuring or termination of employment.
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BASEL Committee disclosure requirements
The Basel committee provides disclosure requirements for Financial Services companies:
Effective from 1 January 2012.
Disclosure should be clear, comprehensive and timely to facilitate constructive shareholder engagement.
Disclosures are to be made annually (at the minimum) and access made readily available:
• Detail to be granular to allow for meaningful assessments by market participants;
• Both qualitative and quantitative information in terms of remuneration practices and policies to be disclosed; and
• Banks are however not required to disclose sensitive or confidential information.
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CRD IV Disclosures
The Capital Requirements Directive (CRD) IV is a European Union (EU) regulation
Effective from 1 January 2014.
This imposes a maximum ratio between variable and fixed remuneration.
Applies to senior managers and material risk takers (EDs and POs) of European banking organisations.
The maximum ratio is:
• 1:1 (without shareholder approval); or
• up to 2:1 (with shareholder approval).
CRD IV is mainly to ensure excessive risk is not rewarded i.e. encouraging too much risk.
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The winter of our discontent
“Plain and not honest is too harsh a style.” ― William Shakespeare, Richard III
Clear and precise disclosure is essential for many decisions, therefore companies need to ensure that “plain” detail is available.
Assumptions will be made that targets / measures do not exist if there is non-disclosure.
Shareholders will vote against resolutions because disclosures are considered “not honest” as sufficient explanation does not exist.
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Closing Statement
Timeous disclosures and an increased level of
transparency, balanced with a need to keep competitive information confidential, will lead to an improvement in
decision making by shareholders.
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