The Only Way is Up

Director specialisation, increased responsibility and the trend towards younger directors are likely to contribute to demands for increased non-executive remuneration in the future, writes Domini Stuart. 

At Cochlear’s October annual general meeting, chair Rick Holliday-Smith told the audience that non-executive director (NED) remuneration had remained unchanged for several years. He wanted the fee cap to be lifted from $2 million to $2.5 million – and shareholders were sympathetic. The resolution was passed with 98.96 per cent of the vote.

Many other chairs could tell a similar story and, where directors have received a pay rise, it has generally been modest. “In my experience the average increase on an annual basis over the past three years has been less than 4 per cent,” says John Egan FAICD, chairman and founder of Egan Associates. “And I don’t think we’re likely to see a significant change to that in 2016 given ongoing economic uncertainty and political instability on a global scale.”

However, Michael Robinson MAICD, director of Guerdon Associates, predicts a continuing trend for S&P/ASX 300 listed companies to request an increase in their fee pool.

“One reason for the requests is that base board and committee fees are adjusted about every two years and, while these increases may have been constrained in recent years, the compounding effect could well have taken them up to the limit agreed by shareholders,” he says.

The process of board renewal is also placing pressure on fees. “This is not just the effect of baby boomers giving way to the next generation in the normal course of retirement,” says Robinson. “As older, wealthy and mainly male directors seek to retire, their replacements are being drawn from more expensive cohorts of younger and technologically savvy NEDs.”

All proxy advisers now report on director shareholdings and shareholding guidelines.

Robinson explains that the increase on fees stems from the changing dynamics of board composition: “Older, male NEDs have typically retired from executive life and, as they have had time to accumulate wealth, need the money less than they want the mental stimulation that comes with sitting on a board.

“By contrast, their younger counterparts are still working in stimulating jobs and, as consultants or executives, may be able to receive two or three times the effective hourly rates they can an earn as a NED. As they are still in the accumulation phase of their life, money is more important to them.

“They are also in hot demand. We have already observed that experienced female NEDs have full dance cards. The tech-savvy will soon be following in their wake as companies navigate the challenges and opportunities of technological disruption.”

More responsibility

In this time of constraint, smaller organisations have been more inclined to adjust director fees than their larger counterparts. However, this may change as directors of companies of all sizes consider whether their remuneration is falling out of step with a more challenging competitive environment and a burgeoning workload.

“In some cases, new committees are being established and, in others, committee members are being burdened with more responsibilities,” says Egan. “For example, many remuneration committees are now taking on responsibility for succession planning, talent management and oversight of the organisation’s culture. Boards are also increasing their focus on risk management and some are opting to separate this out from audit and compliance.

“The board can address these increasing demands in one of two ways – by adding more directors to the board or demanding more of the ones they have. Where they opt for the latter an adjustment to fees would seem fair.”

Some directors face a temporary increase in their workload due to litigation, a project requiring major capital expenditure, international expansion or significant acquisition or divestment activity. In this case, they may be compensated with a one-off consulting payment rather than an increase in their annual fees.

“I think boards will look at different ways to meet the challenges but any increase will be easier to accommodate if there is fresh air in the fee pool already approved by shareholders,” says Egan. “If shareholder approval is needed, it is more likely to be forthcoming when the business is travelling well from an investor point of view. If it isn’t and, as a result, pay increases for the executive staff have been curtailed, shareholders will generally expect the board to take the same medicine.”

Whatever the circumstances, there is no suggestion that the ratio of chair to director fees will change in the foreseeable future.

“Regulatory imposts, especially in financial services, have affected all directors more or less equally,” says Robinson.

Skin in the game

The Australian Council of Superannuation Investors (ACSI) believes that the directors of well-governed boards should have an equity stake in the company that they serve. But, according to its 14th annual report into ,em>Board Composition and Non-Executive Director Pay in ASX200 Companies, nearly 11 per cent of ASX 100 non-executive directors have no “skin in the game”.

“This is a poor result and we hope the number begins to improve,” says Louise Davidson, ACSI’s CEO. “While we don’t mandate how many shares an individual director should own, we do believe that having skin in the game aligns directors more closely with the investors they represent.”

All proxy advisers now report on director shareholdings and shareholding guidelines. Tax changes to employee share plans that took effect on 1 July 2015 have also made it easier for director fees to be provided as equity in lieu of cash.

“At this stage we have seen only a few clients take advantage of this but we expect the numbers to pick up markedly in the next financial year,” says Robinson.

“The subject has been raised by investors in proxy adviser roundtables and feedback sessions. One proxy adviser this season has rapped companies over the knuckles for having director shareholder guidelines in place but failing to enforce them.”

Small, cash-starved start-up organisations might use options or rights with no performance hurdles to attract directors who could earn significantly more on a more established board. Egan also knows of companies outside the ASX 200 that are taking advantage of the new legislation to prevent directors from exercising their rights or options until they retire from the board.

“As long as they remain a director they retain a commitment so, whether the share price goes up or down, they are aligned to the welfare of shareholders,” he says.

But, overall, Australia is lagging behind the US and Europe in NED shareholdings and shareholding guidelines.

“Many boards fail to recognise that a good proportion of their shareholders are foreign pensions and mutual funds that are used to these practices in their home countries and therefore have tougher requirements,” says Robinson.

THE YEAR AHEAD FOR DIRECTORS
  • Pressure to raise fees is likely to increase this year as even modest adjustments to base board and committee fees take organisations close to the cap agreed by shareholders.

  • Dramatic increases are unlikely in an environment of economic uncertainty and political instability.

  • Younger, more expensive and highly-sought-after female and tech-savvy directors are baulking at the low fees being paid for a burgeoning workload.

  • More established directors may also feel that their remuneration is out of step with a growing burden of responsibilities.

  • The ratio of chair to director fees is not likely to change.

  • The number of directors with an equity stake in their companies should increase as proxy advisers and organisations such as ACSI push for directors to have more “skin in the game”.