Culture and remuneration

Executive remuneration has been at the forefront of investor and media attention for some decades, and remains a critical item on the agenda of boards across corporate Australia and globally.

But an issue that has traditionally received limited attention is now gaining prominence. Front line remuneration – how we incentivise and reward customer-facing staff is pivotal to company culture and customer outcomes.

The Hayne perspective and APRA

In the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Commissioner Hayne observed that, in almost every case, the conduct at issue was not driven only by the relevant entity’s pursuit of profit. It was also driven by individuals’ pursuit of gain, whether in the form of remuneration for the individual or profit for the individual’s business.

In many cases, variable remuneration arrangements incentivised behaviour that was adverse to customer interests.

As Commissioner Hayne identified, there needs to be a focus on how performance is delivered.

In commenting on the practice to pay front line employees in banks fixed and variable remuneration (typically rewarded, at least in part, on the basis of financial metrics linked to product sales), Commissioner Hayne acknowledged that, on its face, this is unsurprising:

“…Banks are commercial enterprises. Why not encourage and reward sales? And focusing on sales or profits provides concrete, quantifiable measures of performance. What could be simpler or better?

There is a short and obvious answer. Focusing only on what is to be sold is not enough. How the employee does the job is at least as important as what the employee does…”

Ultimately, Commissioner Hayne recommended that all financial services entities should review, at least once each year, the design and implementation of their remuneration systems for front line staff. This is to ensure that the design and implementation of those systems focuses not only on what staff do, but also how they do it.

The Commissioner also made several recommendations relevant to APRA’s supervisory work, including:

  • In conducting prudential supervision of the design and implementation of remuneration systems, and revising its prudential standards and guidance about remuneration, APRA should have, as one of its aims, the sound management by APRA‑regulated institutions of not only financial risk but also misconduct, compliance and other non‑financial risks.
  • In revising its prudential standards and guidance about the design and implementation of remuneration systems, APRA should, amongst other things, require APRA-regulated institutions to design their remuneration systems to encourage sound management of non-financial risks. This is to reduce the risk of misconduct and require the board of APRA-regulated institutions (whether through its remuneration committee or otherwise) to make regular assessments of the effectiveness of the remuneration system in encouraging sound management of non-financial risks, and reducing the risk of misconduct.

APRA’s draft guidance on remuneration is expected to be released imminently – within a matter of weeks – for consultation. In addition to the significant implications it will have for executive remuneration, it will likely deal with the approach to remuneration systems more broadly. (Currently, the remuneration requirements in APRA Prudential Standard CPS 510 are largely focused on executives, although they do capture other employees whose activities – individually or collectively – may affect the financial soundness of the institution.)

It seems inevitable that the new APRA guidance will have ramifications for other sectors of the economy.

Financial services practices and the Sedgwick Review

For banks, board involvement in front line remuneration is not a novel concept.

Notably, in 2017, Mr Stephen Sedgwick AO released the final report of his Independent Review of product sales commissions and product-based payments in retail banking in Australia.

Mr Sedgwick made recommendations about remuneration structures for retail bank staff, including that:

  • banks remove variable reward payments and campaign related incentives that are directly linked to sales;
  • eligibility to receive any variable reward payment should be based on an overall assessment against a range of factors that reflect the breadth of the responsibilities of each role; and
  • variable reward payments should ultimately amount to a relatively small proportion of fixed pay.

Significantly, he also recommended that boards and CEOs should visibly and effectively oversee the implementation of these recommendations for at least the next five years, and report publicly on how retail staff are remunerated and how their performance is assessed. He also recommended that boards and CEOs ensure that effective, safe channels are in place to obtain feedback from frontline staff about their perceptions of the effectiveness of the reform effort, including in respect of whistleblower arrangements.

Mr Sedgwick recently completed an interim review into implementation of the recommendations. He noted that progress has occurred and that the clear trend is towards policies that will be fully consistent with the Recommendations in respect of in-scope bank staff well in advance of 2020. Notably, all banks provided evidence that their board and CEO have actively considered the implications of the 2017 Review for their business.

In his final report, Commissioner Hayne recommended that banks should implement fully the recommendations of the Sedgwick Review. In the Commissioner’s view, however, implementation of the Sedgwick recommendations “is only the first step”, with banks needing to “continue to give frequent and considered thought to how their variable remuneration systems are structured: to whether they are geared not only to what employees do but how they do it.”

It’s also worth mentioning that the Productivity Commission’s report titled Competition in the Australian Financial System recommended that all banks appoint a Principal Integrity Officer (PIO) – with a direct line to the board – to protect against incentive payments which conflict with customer interests. Then Treasurer, Scott Morrison, called the idea an “interesting one that we will give very serious consideration”.

So what does all this mean for non-financial services boards?

The misconduct highlighted at the Financial Services Royal Commission hearings, including the link between misconduct and remuneration, has broad implications. Boards outside financial services may also wish to reconsider whether they require a greater level of oversight over remuneration practices – and the behaviours they drive – throughout their organisation.

Of course, it must be acknowledged that remuneration is not the only lever available to influence culture. Remuneration policy and practices sit within a broader cultural ecosystem that includes other people-focused processes, general governance policies and risk controls. A holistic governance review is necessary to ensure alignment and consistency across the cultural ecosystem.

Some non-financial services boards have implemented measures to ensure a greater level of oversight of front-line and other employee remuneration, including tasking the board’s People or Remuneration Committee with oversight of organisation-wide remuneration practices. However, practice is varied.

The responsibilities of a People or Remuneration Committee (as outlined in governance charters) may range from periodic oversight and reporting, through to specific approval requirements for the company’s remuneration framework and approach.

ASX 100 examples of responsibilities of People or Remuneration Committees

In order to fulfil its responsibilities to the Board, the Committee will:

  • conduct regular reviews of, and monitor the implementation of, the Company’s remuneration framework and policies, to ensure they:
    • encourage and sustain a culture aligned with the Company’s values;
    • support the Company’s strategic objectives and long-term financial soundness; and
    • are aligned with the Company’s risk management framework and risk appetite;
  • ensure the Company’s remuneration framework and policies include guidance as to how remuneration packages should be structured to:
    • appropriately incentivise positive risk behaviour and improved patient outcomes;
    • discourage unnecessary and excessive risk taking; and
    • allow for proper adjustments when risk and compliance failures occur;
  • make recommendations to the Board regarding proposed changes to the Company’s remuneration framework and policies

The main responsibilities of the Committee in relation to human resources and remuneration policies are to:

  • Recommend to the Board any changes to the overall Group policy regarding remuneration.
  • Oversee the establishment and implementation of appropriate human resources policies and specific remuneration policies (within the overall policy approved by the Board) for the Group.
  • Oversee the remuneration framework applied across the Group, and make recommendations to the Board as appropriate.

How do we consider how we incentivise and reward customer facing staff?

Unfortunately, there is no easy answer.

As a start, it is important to decide, document and communicate upfront the matters that will be taken into account – such as alignment of behaviours to codes of conduct and company values and taking initiatives and owning outcomes – and who is accountable for decisions.

It is also important to consider how any metrics used to determine variable remuneration outcomes are chosen. A common customer-focused metric is linked to a company’s Net Promoter Score (NPS) – a customer satisfaction metric that measures a customers’ willingness to return for another service as well as to make a recommendation to their family, friends or colleagues. A more nuanced metric, which looks at outcomes rather than just satisfaction, may be appropriate for some companies. For example, in the context of retail banking, one of the Sedgwick recommendations was that “all customer measures should be genuinely customer-centric and tailored to the role being assessed, and progressively reflect a focus on customer outcomes not just customer loyalty/satisfaction”.

Many entities are also implementing remuneration accountability frameworks to ensure that leaders and employees are appropriately rewarded for positive behaviours, and held to account for negative outcomes and behaviours. These frameworks set out the types of events and behaviours to be considered, and provide increased rigour, consistency and fairness as to how they are assessed and any consequences determined.

Questions for boards to ask about front line remuneration

  • Why do our front-line roles need to have incentives in place at all? What outcomes are we seeking to achieve?
  • How do the incentives in place balance the company’s profitability with ensuring positive customer outcomes?
  • How are the metrics aligned with delivering positive customer outcomes?
  • Is the design of incentives aligned with the company’s purpose, strategy and values?
  • Is the quantum of the opportunity appropriate (i.e. enough to motivate, but not too much to drive a myopic focus)?
  • Have the incentives been stress tested for different potential outcomes for the company and for the customers, and have we considered unintended consequences?

If a board has not previously had a role with regards to front line remuneration, but is considering broadening its remit, it should also consider:

  • What lens it wants to apply – for example, will it consider group-wide remuneration through a culture and behaviour lens rather than a traditional remuneration lens?
  • Will the board approve policy and/or design, or simply be provided with oversight?
  • Will the board have a role in approving remuneration outcomes?
  • How often will a board-level review of the company’s remuneration framework take place?
  • Does the company’s remuneration framework vary by business unit or country and, if so, what does this mean for board oversight?
“We have a standing agenda item to review an area of the business and the remuneration structures. We review the objectives, outcomes and seek to understand where we might get unintended consequences and how these are measured and managed.”
Kathleen Conlon, Non-Executive Director of Lynas Corporation, REA Group Limited, Aristocrat Leisure Limited and The Benevolent Society