Meeting the ESG

The widespread impact of the COVID-19 pandemic coupled with recent high-profile governance failings have put proxy advisors on high alert.

Hot button issues such as board accountability, management of ESG expectations and executive remuneration will continue to attract close scrutiny from shareholders, proxy advisors and regulators - we take a look at what to keep an eye on this 2020 AGM season.

1. Board accountability

It is clear from recent events at AMP and Rio Tinto that the conduct in these instances has fallen short of community, stakeholder and shareholder expectations. Poor process or judgement in decision-making has caused harm both to stakeholders and to corporate reputations.

During a recent webinar on how to prepare for the Australian proxy season proxy advisor, CGI Glass Lewis, put boards on notice that “when things go pear-shaped” there is an expectation boards will turn their minds to the chain of accountability. “Even sins of omission require the board to consider accountability” says Daniel Smith, General Manager APAC, CGI Glass Lewis. Boards must set a clear tone from the top on their cultural expectations of management and of themselves. When things do go wrong, shareholders and the community expect to see consequences applied, and transparently.

As demonstrated in recent years, where accountability over the handling of certain events is not sufficiently addressed by the board, shareholders are increasingly willing to exercise their voting power against individual directors’ re-election to the board. This is expected to be a continuing theme this AGM season.

Deterring poor behaviour and improving the management of key risks to minimise harm to stakeholders will also continue to be a key strategic priority for the corporate regulator, says ASIC Chair, James Shipton, speaking at the AICD’s recent Essential Director Update.

In a clear sign of ASIC’s continued focus on the governance challenges facing corporate Australia, the once ad hoc ASIC Corporate Governance Taskforce is now permanently embedded into ASIC’s broader supervisory activities. A further near-term focus will be promoting a greater “speak-up culture” via implementation of Australia’s strengthened whistleblower regime.

These are important initiatives that will provide an appropriate check for boards and management – ultimately improving organisational culture by ensuring stakeholder voices are brought to the board table and helping to avoid surprises come AGM time.

According to a recent BlackRock stewardship report covering the 2019/2020 AGM season, other key areas attracting greater shareholder scrutiny include insufficient progress on board diversity; director over-boarding; and a lack of director independence – particularly with respect to shareholder nominee influence on boards.

2. Shareholder activism on ESG issues

Although by no means a new trend, ESG issues continue to be at the forefront this AGM season.

AGL Energy recently suffered its first strike on the remuneration report at its AGM earlier in October. Almost half the proxy votes rejected the remuneration report amid concerns over a new executive pay structure tying carbon reduction objectives to its long-term incentive plan as a means of encouraging a transition to clean energy. CGI Glass Lewis and ISS Australia criticised the new design for offering bonuses for executives merely performing their day job, saying emissions reductions alone “should not be worthy of significant bonuses”. This serves as a clear warning shot from proxy advisors that addressing climate risks should not be seen as an optional extra, and is a base-line expectation.

So how should boards be thinking about ESG matters? And how does one benchmark their organisation against its peer companies? Recognising that not all ESG issues matter equally, CGI Glass Lewis recommends looking at ESG matters through a risk management lens and determining what are material for the business (in other words, information which would be considered decision-relevant to an investor). For example, risks in the supply-chain such as the exploitation of labour may be greater for a supermarket chain, as compared with a utility company.

Notably, groups such as the Task Force on Climate-Related Financial Disclosures (TCFD) and Sustainability Accounting Standards Board (SASB) have developed frameworks that act as important reference points for determining materiality of ESG issues in each industry or business line. Proxy advisors and investor groups such as ACSI implore boards to familiarise themselves with these indicators and ensure they are being reported against accordingly. To the extent there is inadequate disclosure, proxies expect this to be addressed as a matter of priority.

In what has already been a volatile few months for ESG matters in Australia, proxy advisors expect shareholder and community focus on ESG risks, both globally and closer to home, to only intensify going into 2021 and beyond.

3. Executive remuneration

As a now perennial feature in the Australian corporate governance landscape, executive remuneration is set to be back in the spotlight this AGM season given the widespread impact of the COVID-19 pandemic on employees, customers, shareholders and broader community.

Overall, boards were quick and decisive in responding to the issue of executive pay as COVID-19 first took hold in Australia. As CGI Glass Lewis reports, of 61 ASX300 companies surveyed recently, 90% reduced CEO pay and non-executive director fees.

Earlier in the year, we took a look at what companies were doing in this space - encouraging boards to engage in introspection regarding how executive bonuses might be perceived internally and externally (see article here).

Fast-forward six-months and we are beginning to see the rubber hit the road. So where should remuneration committees be devoting their time with respect to executive pay outcomes this AGM season?

Proxy advisors suggest directors interrogate two lines of inquiry:

  1. Can pay for performance be justified?
  2. How is board discretion being applied to pay outcomes?

Can pay for performance be justified?

In assessing the reasonableness of executive bonuses relative to performance in the context of COVID-19, CGI Glass Lewis point to four broad scenarios as a point of reference:

  1. Performance has been hit hard and the company’s prospects are at risk of failure. It is only in these limited circumstances where discretionary upwards adjustments or retention awards may be warranted this year.
  2. Performance has been negatively impacted, but the company remains solvent. This is a particularly grey area, but it is hoped that the financial portion of scorecards are reflective of trading conditions (i.e. in many cases zeroed) – particularly where profits have been propped up by JobKeeper or other stimulus payments. However, this may be tempered where there is achievement of non-financial measures.
  3. Performance has not been impacted. This is ‘business as usual’ and expect pay outcomes to be assessed as they would in any other year.
  4. Performance has sky-rocketed, although often through sheer-luck. Windfall gains – particularly due to pandemic panic purchasing – may be a financial sugar hit, but not reflective of executive performance. Big bonuses will be scrutinised and must be justified.

How is board discretion being applied to pay outcomes?

When proxy advisors are looking at how board discretion is exercised, CGI Glass Lewis recommends taking a common-sense approach and “showing your work”. Where there is any discretionary upwards adjustment applied, there must be a way to join the dots.

In June, ASIC released guidance for board oversight of executive variable pay decisions during the COVID-19 pandemic. In doing so, ASIC observed that effective board oversight and exercise of discretion on pay outcomes is enhanced where it is guided by frameworks and made with the benefit of contextual information from unbiased sources and arrangements to manage conflicts of interest; and are transparently recorded and communicated.

Most importantly, ASIC’s guidance encourages companies to disclose when discretion has been applied, and the rationale for its exercise. “This is particularly relevant in the current environment where there may be decisions to significantly reduce or even cancel awards, or conversely to pay an amount where targets have not been met”.

In speaking at the AICD’s Essential Director Update, ASIC Chair, James Shipton signalled that executive remuneration will continue to be a core focus for the corporate regulator. While there may now be maturity around the mechanics and governance aspects of remuneration frameworks, more work still needs to be done on how board discretion should be applied.

Going forward, proxy advisors suggest boards continue to treat executive pay as a hygiene issue to incentivise the right behaviours and support better oversight of corporate decision-making. Some of the changes that may be on the horizon for remuneration structures include:

  • simpler remuneration structures with discretionary levers built in up-front;
  • reduced overall quantum of CEO pay but with increased fixed pay;
  • fewer metrics, but a greater focus on financial and non-financial performance related to recovery;
  • longer deferral periods for equity; and
  • better practices and frameworks for consequence management.

4. Virtual and hybrid AGMs

Of course, COVID-19 continues to create challenges for organisations seeking to hold a physical AGM this year. In an important step towards the modernisation of Australia’s ageing corporations law framework, the Government announced in October’s Budget its commitment to making permanent the temporary COVID-19 reforms (valid until 21 March 2020) which allow companies to hold virtual and hybrid AGMs.

As an important component of maintaining corporate accountability, boards must ensure members are afforded a reasonable opportunity to participate. In doing so, the Australian Shareholders Association (ASA) encourages organisations to ensure an online AGM feels as close as possible to a physical AGM for members. Critically, this must include an opportunity to ask questions and make comments. In this respect, members and other stakeholders will be watching closely to see how boards adapt to the online format.

For further guidance on shareholder participation at virtual and hybrid AGMs, see AICD director tool here.

Questions for board to ask this AGM season

Board accountability

  • Do organisations’ actions match with their rhetoric?
  • Does the organisation encourage and foster a ‘speak up culture’?
  • Has the organisation engaged with stakeholders on key issues? What perspectives were provided?

ESG

  • What ESG issues present a material risk to the organisation from an investor perspective?
  • Are the right systems in place to oversee ESG risks, both at the full board level and within committees?
  • What frameworks are being used to report these risks against?
  • How is the organisation benchmarking itself against its peers?

Executive remuneration

  • Can pay for performance be justified given the impact of COVID-19?
  • What impacts have there been in the organisation’s ecosystem (e.g. access to government support, employee stand-downs or redundancies, capital raising or impairments)?
  • Where discretion is being applied, is this being guided by a clear framework and clearly communicated?

Virtual and hybrid AGMs

  • Does the technology used to facilitate the meeting enable participants to follow the meeting uninterrupted?
  • Are members able to vote both in advance of, and during, the meeting?
  • Are members given a reasonable opportunity to ask questions and make comments live during the meeting?
  • Is there transparency around the number and nature of comments and questions being asked during the meeting? Are these being recorded and communicated to members?