THE phrases: “What you see is not what I get”, “it is a mirage” and “quantitative sleight” have been commonly bandied around by head-honchos to describe sensationalised news surrounding their remuneration packages. Every time the spotlight shines on the ASTROnomical remuneration of managing directors or chief executive officers (CEOs) with hard-hitting questions on the quantum awarded when their companies are loss-making, these views are met with the typical retort that the figures have been taken out of context.
This flux in large parts lies in the structure of remuneration packages for C-suite members who are also known as top executives. Barring the fixed components, there is a high degree of variability in the remuneration packages of such individuals with the inclusion of variable components such as staggered performance bonus, long-term cash incentives and share options. Whilst the latter three examples are arithmetically quantified and recorded in the annual report, they nevertheless represent deferred components. As such, there is no guarantee that they will completely crystallise and eventually be cashed out by top executives.
In the present tumultuous economic times characterised by the nose-diving of share prices to near rock-bottom levels, the previously granted stock options would clearly be out of the money or valueless and also in the worst case scenario, management head honchos may not even retain their positions to realise the staggered bonus and long term cash incentives over a designated period of time. Against the backdrop of such situations, it is sometimes quipped that “remuneration delayed is remuneration denied”. An illustration of the common components that may be present in a typical top executive’s remuneration package is outlined below:
To elucidate further, an analysis by KPMG revealed that variable components form almost 30% of a CEO’s remuneration package across the top 100 Malaysian public-listed companies and this average figure can reach up to 43% in the context of financial institutions with a fairly sizeable proportion of the variable components taking the form of deferred payments. Rather interestingly, it is also noted that the extent of variability and deferral in the remuneration schemes increases as one moves up the management echelon.
The current whipsawing global economic environment brought about by the debilitating Covid-19 pandemic and accentuated by the declining price of crude oil has once again raised existential polemics on the viability of leveraged and phased nature of remuneration modality for top executives. In such discourses, one should always fall back on the underlying principle of the remuneration philosophy. Whilst recalibration of the arithmetical remuneration construct vis-à-vis changing market conditions is an organic process, the principle which underpins the leveraged and phased nature of top executives’ remuneration should continue to hold, namely, symmetrical alignment between remuneration and long-term value creation of the company.
Simply put, rather than reacting to a tepid economy by making hasty deep cuts or out-of-whack realignment in the fixed-variable and current-deferred mix of the remuneration packages, companies should approach the downturn with a calibrated and flexible approach to managing change in line with its value creation strategy. This would allow companies to navigate through to the other side and be in a position to grow rapidly once the market turns the corner.
In adopting a long-term paradigm based on a calibrated and flexible approach, it is important for performance metrics underpinning top executives’ remuneration to be tied to the aspect of sustainability with an emphasis on business resilience, reducing excessive risk taking and reinforcing non-financial measures. Performance metrics instituted should be fair and achievable - yet sensitive to the shareholder experience. Care should also be accorded in determining the extent to which stock options are deployed as well as in establishing the accompanying hurdle rates and the exercise price of stock options. Whilst at first instance it may appear judicious for companies with low cash reserves in the present economic condition to liberally dole out low-valued stock options in lieu of cash payments, a sustained stock market recovery in the future could set-up these top executives for a windfall gain by supercharging the profits when these options are exercised.
As such, at all times, consideration must be given to achieve parallel alignment in the remuneration packages accorded to top executives over a horizon including gains made during the bull market spells versus value generated for shareholders over that defined period.
One calculated approach that could be considered to alleviate unintended consequences in the current anemic economic climate is the introduction of floor and capped payout for long term cash incentives.
A floor payout for the said component could help to keep key talents motivated whilst a capped payout could insulate the company against adverse shareholders’ reaction for payments that are awarded when relative performance metrics are met whilst absolute performance metrics are missed during a financial downturn.
In addition, any benchmarking undertaken in reviewing the remuneration of top executives should not be solely lateral in nature with the only comparators being that of similar positioned top executives across immediate competitors. Instead, the pay of such individuals should also be benchmarked internally and in a longitudinal manner against that of the broader workforce within the company. Whilst it may be far-fetched to adhere to the suggestion by management guru, Peter Drucker who famously posited that CEOs should not earn more than 20 times the average salary in a company, due regard should certainly be given to minimise excessive disparity. To this end, it is heartening to note that Securities Commission Malaysia is undertaking an analysis on CEOs’ remuneration with a review of pay ratios in listed companies for release in its latest iteration of corporate governance publication, namely, Corporate Governance Monitor 2020.
As companies craft plans to weather the bumpy economic ride, remuneration can become more decisive to retaining and motivating top executives in tandem with the company’s value creation trajectory. Companies should therefore not lose sight on the fundamentals of remuneration when being faced with the multifaceted challenges presented by a soft economy.
Instead of engaging in a race to fix the issues on remuneration through palliative means, companies should remain focused on the underlying philosophy with the adoption of a long-term view.
One should be mindful that a company’s precipitous action could be its own worse enemy – in short, never abandon the principle of promoting congruence between remuneration and value creation. As the third President of the United States, Thomas Jefferson has aptly put it, “in matters of style, swim with the current; in matters of principle, stand like a rock”.
Kasturi Nathan is partner and head of governance & sustainability, KPMG in Malaysia while Krishman Varges is associate director, governance & sustainability, KPMG Management & Risk Consulting Sdn Bhd. The views expressed in this article represent the individual perspectives of the writers and do not necessarily represent the official views of any affiliated organisations.
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