First published in Business Times on January 23, 2018

By Mak Yuen Teen and Chew Yi Hong

On Jan 11, we released our first report on remuneration practices for 609 companies with a primary listing on the Singapore Exchange (SGX). The report, titled The Singapore Report on Remuneration Practices: Avoiding the Apaycalypse, highlights good practices – and practices that fall below generally accepted norms. It identifies companies that got the basics right, especially in terms of compliance with the Singapore Code of Corporate Governance on remuneration committee composition and remuneration disclosures.

In selecting the companies, the following criteria were used:

  • Remuneration committee composition which complied with the Code and any other rules applicable to the company;
  • Exact disclosure of remuneration and breakdown for at least the directors and the CEO;
  • Disclosure of the fee structure for non-executive directors (NEDs);
  • Disclosure of the aggregate remuneration for five key management personnel (KMP);
  • Identification of the KMP and disclosure of remuneration in bands no wider than S$250,000 for at least five KMP;
  • NEDs were not eligible to receive share options, share incentives or other remuneration components linked to the performance of the company or to the remuneration paid to management;
  • All remuneration components were put up for shareholders’ approval;

(Note that in this article, the term “NEDs” includes independent directors or “IDs”.)

The above criteria are not high bars based on international norms. However, the list of companies that made the cut fell very quickly. Based only on the first three criteria, just 53 out of the 609 companies made the cut. After the next two criteria, the number fell to 32 companies.

A further 19 dropped out because NEDs were eligible to participate in share options or other performance-based incentive schemes. Companies were excluded even if share options or performance shares had not been granted yet because eligibility meant that the company could grant them at any time. While our current Code does not specifically discourage granting of share options or performance shares to NEDs, we believe such remuneration components are inappropriate for NEDs.

Corporate governance codes in countries such as Australia and the United Kingdom discourage them and consider them to be a factor in assessing independence of directors. We found more than 180 companies, or 30 per cent of all the companies covered in our study, allow NEDs to participate in such schemes.

This left us with the “lucky 13” companies that made the cut, comprising six large caps, one mid cap and six small caps. The large caps that made the list are CapitaLand, Fraser and Neave, Frasers Centrepoint, Jardine Cycle & Carriage, Singapore Exchange and Singapore Telecommunications. The sole mid cap is Tuan Sing. The small caps are Baker Technology, Dynamic Colours, MTQ Corporation, Nera Telecommunications, SP Corporation and Tai Sing Electric.

It may come as a surprise that the list is not dominated by large caps. Within the large caps on the list, there are some that are well ahead especially in terms of disclosure of performance measures and vesting conditions for share-based schemes for key management, such as SGX and Singtel. However, we selected companies which we felt got at least the basics right, not based on how sophisticated their remuneration framework is.

Share-based incentives may not align interests

While remuneration “best practice” generally suggests an appropriate balance between annual salary, short-term incentives and long-term incentives, and a combination of cash-based and share-based remuneration, not all 13 companies have these components. For example, Tuan Sing explained that it did not have any long-term incentive or share-based schemes because “the Board is of the view that such long-term incentive plan is not effective and that it is difficult to determine how much such long-term incentive plan contributes to the retention of employees and/or motivating desired performance. The employees might not view it as “long term” – disposing of shares when they are vested, rather than holding the shares and receiving dividend payments and enjoying future share price appreciation”.

In our experience, and based on company disclosures, it is not at all clear that so-called share-based incentives actually align the interests of those receiving them with the long-term interests of the company. Such schemes are only effective if there are appropriate performance measures and vesting conditions in place and/or selling restrictions. For example, a share option scheme with a short vesting period and no selling restrictions for shares after exercise is just a short-term incentive scheme that does not align the executive’s interest with the long-term interest of shareholders. A poorly designed incentive scheme is worse than not having one.

Remuneration shares and share ownership guidelines for NEDs

Granting share options and performance shares to NEDs should not be confused with using restricted or remuneration shares for these directors. In our study, we found at least 17 companies using the latter. We support such share-based remuneration for NEDs provided certain conditions are in place. They should vest immediately with no vesting conditions that are linked to the future share price or financial performance of the company, and there should be a selling moratorium that requires NEDs to hold the shares until at least the time when they leave the board. These conditions ensure that the NEDs are not focused just on improving the share price or bottom line, or trade shares based on short-term considerations, and that their interests are aligned with the long-term interest of the company.

Most, but not all, 17 companies that use such restricted or remuneration shares disclose these features. CapitaLand was one of those which did. Others like Singtel have share ownership guidelines for NEDs designed to achieve the same objective. However, we noticed that Singtel has not yet been able to fully implement the guidelines, despite its encouragement to its directors to buy and hold the equivalent of one year’s fees in shares while they remain on board because most of the NEDs either do not yet hold Singtel shares or hold too few to meet the guidelines.

What pay for what performance?

Guideline 8.1 of the Code recommends that “a significant and appropriate proportion of executive directors’ and key management personnel’s remuneration should be structured so as to link rewards to corporate and individual performance”. In our study, we found that, on average, the variable components in the form of the cash bonus, other variable incentives and share-based remuneration increase as companies become larger. For example, a small-cap CEO received an average of 74 per cent in fixed salary and 16 per cent in annual bonus and other variable incentives, compared to 55 per cent and 38 per cent respectively for a mid-cap CEO, and 38 per cent and 56 per cent respectively for a large-cap CEO. Note that these percentages are based on actual amounts paid as disclosed in the remuneration table and therefore the variable components are affected by the extent to which the CEO has met his performance targets.

The implementation of “pay for performance” is not always straightforward. Let’s consider the case of an executive director who is also a major shareholder. For such an individual, share-based remuneration may not make sense. Share-based remuneration was introduced largely to align the interest of professional managers with the interest of shareholders. The marginal benefit of using share-based remuneration may be low in such circumstances. Further, chapter 7 of the SGX rulebook imposes restrictions on participation of controlling shareholders and their associates in share option and share schemes, including requiring their participation to be approved by independent shareholders and the basis for their participation and the specific grants to be explained. This would further steer companies away from using share-based remuneration for management who are controlling shareholders.

However, it is also not clear that a profit-sharing or profit-linked bonus plan – a major variable component used by many companies with controlling shareholders who are management – is ideal either. As a large shareholder, he is already entitled to a proportionate share of the dividends and retained profits. Such a plan may also result in excessive remuneration through a high profit share percentage. There is generally little transparency as hardly any company in this situation discloses the profit-sharing percentage or the bonus formula – the only time one would usually see such information is in the initial public offering prospectus.

For management who are large shareholders, it probably makes sense to rely mainly on fixed salary and a cash bonus that is linked to factors other than the company’s financial performance – some form of balanced scorecard. However, the risk of excessive remuneration remains for management who are controlling shareholders because they essentially control the appointment of independent directors who determine their remuneration.

We therefore believe that remuneration paid to management who are controlling shareholders and their associates should be subject to a binding vote by independent shareholders, similar to interested person transactions (IPTs) above five per cent of net tangible assets and recurring IPTs conducted through a general mandate under SGX rules. In effect, such remuneration is similar to IPTs of a revenue nature since they are recurring.

While SGX rules currently provide safeguards (primarily due to concerns about dilution) when controlling shareholders and their associates participate in share-based schemes, there are no similar safeguards for excessive cash-based remuneration.

General principles for effective “pay for performance”

“Pay for performance” should generally be accompanied by the following:

  • A strong ethical culture
  • Good board and remuneration committee governance
  • Transparency in remuneration processes and setting of remuneration packages
  • Appropriate performance measures, benchmarks and targets
  • Balance between fixed remuneration, short-term incentives and long-term incentives
  • High standards of disclosure

With recent news about Singapore companies being involved in bribery scandals, companies should review their corporate culture to ensure that the right tone is set at the top and cascaded throughout the group. A strong ethical culture must underpin a pay-for-performance system. Without the right culture, pay for performance would be like adding gasoline to fire.

Companies should also assess whether the performance measures used and the mix of fixed remuneration, short-term incentives and long-term incentives – from front-line personnel to management to those performing “gatekeeping” or “control” roles – are fostering the right behaviour and are consistent with their roles.

Mak Yuen Teen is an associate professor of accounting at the NUS Business School who specialises in corporate governance, and Chew Yi Hong is an active investor and corporate governance researcher.