Note: In previous articles, I discussed Hyflux’s issue of preference shares and perpetual securities, and its board of directors.  In this article, I discuss issues relating to its remuneration. The next article will likely be about its assurance functions – external and internal audit. These are all parts of a comprehensive case study that will also cover other areas. I hope to do a seminar at some point to discuss all the issues.

By Mak Yuen Teen

Boards are expected to set the corporate culture and the remuneration policies they approve are likely to affect this culture. While the directors may not have personal interest in projects as the company has claimed, did the remuneration policies for non-executive directors and key management promote aggressive risk-taking without adequate mitigation strategies?

Remuneration committee

When the Remuneration Committee was first established in September 2002, it was chaired by Teo Kiang Kok, with other members being Lee Joo Hai, Gay Chee Cheong and Olivia Lum. In February 2005, Christopher Murugasu joined the board as an NED and became a member of the Remuneration Committee. Murugasu was Senior Vice President of Corporate Services at Hyflux just before his appointment as an NED and a member of the committee.

Lum left the committee in FY2006, and Prof Tan Teck Meng joined the board and became a member in FY2007 . The latter took over as Chair in FY2008. In FY2009, Teo resigned from the committee. In FY2011, following the demise of Prof Tan, Gay took over as Chair and Teo rejoined the committee. Lee resigned from the committee in FY2014. Since then, the committee has comprised of Gay as Chairman, with Teo and Murugasu as the other members. Therefore, at various times since the committee was formed in 2002, Gay, Lee, Murugasu and Teo were chairs or members of the committee, with Olivia attending all its meetings on an ex-officio basis since 2008.

Disclosure and amounts of remuneration

Hyflux was not transparent in disclosing remuneration of its directors and key management personnel (KMP), choosing to disclose in bands of $250,000 at best. For KMP who are not directors or CEO, it disclosed up to seven KMP in bands of $250,000, but the lowest band was shown as either below $750,000 or below $500,000 (rather than the Code’s recommendation of bands no wider than $250,000). For Lum and the NEDs, it disclosed in bands of $250,000, rather than exact amounts. At least for the latter, it is unclear how “disclosure may be prejudicial to its business interests given the highly competitive environment it is operating in as well as competitive pressures in the talent market”, as mentioned in its annual reports. Why would disclosing the exact remuneration of the NEDs, or for that matter Lum’s exact remuneration, be prejudicial to Hyflux’s business interests? What competitive secrets will that reveal? Who will poach them to run their companies or be directors, on knowing their exact remuneration?

For Lum and the KMP, remuneration is made up of an annual salary, annual bonus, share options and allowances and other benefits. Lum’s total remuneration has fallen over the years. In FY2010 and FY2011, her total remuneration was in the range of $1.5 million to $1.75 million with the bonus making up 55% and 53% respectively. Share options made up only 4% and 8% respectively. In FY2012 and FY2013, her remuneration dropped to the band of $1 million to $1.25 million but there was a shift towards a significantly higher proportion in the form of share options, with the percentages of 44% and 26% respectively. The cash bonus components had fallen to 4% and 26% respectively. Lum’s remuneration fell further to the band of $750,000 to $1 million in FY2014 and FY2015, with bonuses of 11% in both years, and share options of 22% and 15% respectively. In FY2016 and FY2017, while her total remuneration remained at the same band, the annual salary percentage now accounted for a significantly higher 85% and 87% respectively, with bonus of 7% in both years, and share options of 3% and 0% respectively.

There appears to be inaccuracies in the disclosure of directors’ remuneration under FRS24 in the notes to the financial statements since at least FY2011 as the total amounts disclosed as being paid to directors were lower than the lowest amounts possible based on the remuneration report in the corporate governance statement and the total  fees paid to non-executive directors (and even disregarding the fair value of share options granted to non-executive directors).

The table below shows the amounts disclosed in the remuneration report over the years and the NED remuneration approved by shareholders, versus the amounts shown in the notes to the financial statements under FRS24. I would have expected the “Amounts paid/payable to directors” to be within the range between “Minimum director remuneration” and “Maximum director remuneration”. But since FY2011, this has not been the case.

[Minimum director remuneration is computed by adding the lower band for the EDs, plus the exact NED fees approved by shareholders. Maximum director remuneration is computed by adding the upper band for the EDs, plus the exact NED fees approved by shareholders. Gary Kee was briefly re-designated from NED to ED and then back to NED.]

2010 2011 2012 2013 2014 2015 2016 2017
Remuneration in corporate governance statement and director fees approved by shareholders
Olivia Lum’s ED remuneration $1.5 to $1.75m $1.5 to $1.75m $1 to $1.25m $1 to $1.25m $0.75 – $1m $0.75 – $1m $0.75 – $1m $0.75 – $1m
Gary Kee’s ED remuneration $0.25 – $0.5m $0.5 – $0.75m
NED remuneration $490,000 $540,795 $550,000 $524,384 $478,301 $520,000 $580,000 $580,000
Minimum director remuneration $1.990m $2.041m $1.550m $1.774m $1.728m $1.270m $1.330m $1.330m
Maximum director remuneration $2.240m $2.291m $1.800m $2.274m $2.228m $1.520m $1.580m $1.580m
Remuneration disclosed in notes to financial statements under FRS24 on Related Party Disclosures
Amounts paid/payable to directors $2.227m $2.324m $1.262m $1.002m $0.531m $0.543m $0.596m $0.604m

 

Hyflux is also extremely light on details when it comes to remuneration policy. For executive directors and senior management, it merely says that it is based on service contracts, taking into account performance of the individual, the Group and market trends. It does not indicate what performance measures are used. Looking at Lum’s pay since FY2010, it does seem to be related to some extent to the profitability of Hyflux. However, there was also a shift towards more share option remuneration, especially between FY2012 and FY2015.

Share options

In addition, the NEDs started participating in the share option scheme from FY2006. After an initial grant of 700,000 options in 2006 in total to Gay, Lee and Teo (later adjusted to 1,050,000 following a 1-for-2 bonus issue), further share options were granted each year from FY2010 to FY2017. Murugasu already had 862,500 options granted to him as a senior executive of Hyflux when he joined the Board as an NED.

Unlike Lum and other employees for which the options have a 10-year life, the options for NEDs have a five-year life, exercisable after one year. [On several occasions, the company’s announced the grants to NEDs together with those granted to employees, which showed all the options having 10-year life. However, based on other disclosures made by the company, it appears that options to NEDs expire after five years, exercisable after one year.]

Cumulatively, the directors other than Lum received 8,234,375 options since FY2006, exercised 2,134,375 of them, with 3.15 million options having expired. The estimated fair value of these options was $1.973 million. Like many other companies here, Hyflux only put the cash fees for NEDs to shareholders’ approval at its AGM, even though since FY2010, the fair value of share option grants amounted to an estimated 40% of the total cash fees of $4,263,480  over that period.

While it appears that those having more responsibilities received more options, this was not always the case each year. It also does not appear that the number of options granted were based on the estimated fair value of each option at a particular time. The total fair value of options granted each year ranged from a low of $36,300 in 2016 to a high of $1.134 million in 2010.

It is also of concern that the directors who were responsible for administering the share option scheme and determining the amounts to be granted over much of the period were also the ones who received the most share options, including Gay, Teo, Lee and Murugasu.  How did the committee decide on the number of options to be granted to each director and in a particular year? Even though directors are not supposed to be involved in determining their own remuneration, the committee members were certainly in a position to influence the amount of options granted to each other. Unfortunately, Hyflux was not transparent in how the number and allocation of options granted were determined.

Beyond the issue of the quantum and value of the share option grants to NEDs and the fact these were not included with the NED fees approved by shareholders, the increase in share option grants to Lum and the active participation of the NEDs in the share option scheme may be indicative of an aggressive risk-taking culture in the company. Since the payoffs from share options are asymmetrical (unlimited upside and limited downside risk), they tend to encourage risk-taking. As more options were granted each year and the cumulative un-exercised and un-expired options built up, the incentive to take on even more risk to try to increase the share price may increase over time.

Did the participation of the NEDs in the share option scheme undermine their oversight role, including their responsibilities in ensuring proper risk management? Is it appropriate that the lead independent director and the Chairman of the Audit Committee, for instance, are remunerated with share options? How is that different from linking the remuneration of executives in control job functions (such as internal audit and risk management) with corporate performance or share price performance? Or does Hyflux reward those in control job functions with options too?

Concluding thoughts

In my view, the Hyflux case illustrates clearly the issues when NEDs participate in share option schemes or any other scheme which results in NED remuneration being driven by the company’s financial performance or share price. It is not a surprise that the report “Avoiding potholes in listed companies”, written by my colleague Richard Tan and me, found the use of share options for independent directors to be one of the 16 warning signs/red flags that differentiated companies that got into serious trouble and those that did not.

If there is an intention to align the interest of NEDs to shareholders, the preferred way to doing this is to require NEDs to use some of their cash fees to buy shares in the company and to hold those shares until they leave the board. I should add that while I do support this practice, I believe it is more “optics” than having a direct impact on the behaviour of NEDs as I doubt that holding shares equivalent  to a year or so worth of fees will really align interests much (and too much shares will likely compromise the independence of directors). At the end, good independent directors are not likely be much influenced by how much or how they are paid – they will just do the right thing.