Note: This is the third in a series of articles on remuneration
By Mak Yuen Teen
Some years ago, I was sent a report by remuneration consultants who were engaged by a Singapore-listed company to benchmark the CEO’s pay. I was asked to assist in a “quality review” as head of research. The report said that the CEO was underpaid relative to his “peer group” and it was recommended that his pay be increased.
I asked if the company has an executive chairman. Yes, the consultants said. I then suggested that the consultants obtain the job responsibilities of the executive chairman and the CEO. It turned out that the CEO was performing a COO role. I said that the individual’s pay ought to be benchmarked to other COOs.
This raised another issue – some of the CEOs in the “peer group” selected for benchmarking may also not be “real” CEOs. There were also the issues of whether the peer companies selected were appropriate and a relatively small sample size.
This case illustrates some of the common problems with benchmarking.
Benchmarking
Many companies engage remuneration consultants to advise on setting the remuneration of directors and employees, and benchmarking is often used.
For instance, the Singapore Exchange (SGX), which in my opinion, has the best remuneration disclosures among listed companies here, discloses in its FY2021 annual report that “SGX benchmarks the total compensation for employees against local and regional institutions using market data provided by McLagan (Singapore), a business unit of Aon Solutions Singapore Pte Ltd.” For non-executive directors (NEDs), remuneration is determined by “taking into account the scope and extent of a Director’s obligations, benchmarking against Singapore-listed companies of similar size and to a lesser extent, global bourses, the need for market competitive compensation levels to attract and retain the right talent, market trends on a national level and best practices for corporate governance”. Base salary for its employees “is pegged to the 50th percentile of market pay data in the Singapore banking and financial services industry”. For its performance share plans (PSPs), performance targets for vesting include relative total shareholder return compared to “selected peer exchanges” and “Straits Times Index peer companies”.
Just on the selection of peer companies for comparison alone, there are many decisions requiring judgements by remuneration consultants and RCs.
Often, there is just not enough data for benchmarking or the data is highly contaminated or lacking. In the first article in this series, I discussed the generally poor disclosure of remuneration among Singapore-listed companies. This makes benchmarking even more difficult than in other markets that are more transparent. The number of companies in a sector may also be small – and including peer companies in other countries introduces different issues such as differences in cost of living, taxes and market norms.
Benchmarking has also been blamed for the ratcheting up of executive pay as most companies would set pay at or above the median pay of the peer group, and over time, this drives up executive pay.
In SGX’s case, it pegs the base salary of its employees to the 50th percentile in the “Singapore banking and financial services industry”. Most companies that use benchmarking will benchmark to the 50th percentile or higher, rather than below the 50th percentile. But if everyone benchmarks to the 50th percentile or above, it will drive up pay levels over time.
Copyright for cartoon belongs to Mak Yuen Teen and Chris Bennett
Changing goalposts
Research shows that “peer companies” used in benchmarking often change over time. A study of Equilar 500 companies published in August 2020 found that 91.8% used peer group benchmarking for compensation plan design purposes, with 71.9% having 10 to 20 companies in their compensation peer group, and the most common peer group size is 16. Nearly two-thirds of those practising peer benchmarking have made changes to their peer groups. There may be good reasons for such changes, but there is also the risk of gaming behaviour.
At SGX, the peers used for the vesting of performance shares for the relative total shareholder return (TSR) performance measure in the original PSP were those in the FTSE/MV Exchanges Index, which consists of listed global exchanges. When the current CEO joined in FY2015, which coincided with the introduction of a new PSP, peer companies used for relative TSR became “selected peer companies”, with no information on what these are. In FY2018, peer companies were “selected peer exchanges” and “selected Straits Times Index companies” – it is unclear whether they were the same as “selected peer companies”.
Over the years, the performance measures (which SGX calls performance targets) for the vesting of the performance shares have also changed. In the original PSP, the performance measures were return on equity (ROE), absolute TSR and relative TSR. The performance measures in the new PSP introduced in 2015 became earnings per share (EPS) growth and relative TSR against selected peers, equally weighted. Absolute TSR was dropped.
In FY2018, the performance measures were changed again, to strategic and non-financial priorities (40% weighting), EPS (30%), relative TSR against selected peer exchanges (15%) and relative TSR against selected STI companies (15%).
The change from EPS growth to EPS significantly lowered the EPS target that has to be achieved. For example, for the FY2017 grant, “at target” performance level for EPS growth was a 3-year compound annual growth rate (CAGR) of 6.2% and this was weighted 50%. For the FY2018 grant, “at target” performance level for EPS was an average of 34 cents over three years, and the weighting was reduced to 30%. The FY2018 diluted EPS was already 33.8 cents. To consider one scenario, a 0.5% EPS growth in FY2019, followed by 0% EPS growth in both FY2020 and FY2021, would achieve the 3-year average EPS of 34 cents.
SGX did not disclose the rationale for the above changes.
RCs should question the rationale for changes in peer groups, performance measures and performance targets. There may be good reasons linked to changes in the business and strategies but there could also be gaming behaviour.
At least in SGX’s case, shareholders who pay attention can observe these changes and ask questions. For virtually all other companies here, they would be in the dark.
Malus and clawback provisions
In part 2, I discussed the problem with annual cash bonuses linked solely or mostly to profits. This particularly problematic in the absence of deferral of bonuses which can subsequently be forfeited. Some large companies, including GLCs here, use a bonus bank system to defer part of the annual cash bonuses. But founder and family managed companies here rarely do so.
With a bonus bank system, bonuses that have not been paid out can be reduced or cancelled, such as if future performance is poor. This can encourage executives to consider longer-term implications of their decisions.
Companies can also have malus provisions to reduce or cancel deferred bonuses and unvested share options and shares awards in situations such as poor performance, misconduct or firm-wide failures.
In contrast, clawback provisions allow the company to recover remuneration after it has been paid out, which is far more challenging to implement in practice. Clawback provisions generally apply in more limited circumstances than malus clauses, such as where there are material misstatements of financial results or gross misconduct, but not poor financial performance.
In the Wells Fargo case in the U.S., its former Chairman and CEO John Stumpf gave up US$41 million in unvested equity awards shortly before he resigned, while the former head of the bank’s community banking division, Carrie Tolstedt, had US$19 million of unvested equity awards forfeited, following the revelations of the cross-selling scandal. After an investigation, the board also determined that “cause existed” for Tolstedt’s termination, requiring the forfeiture of another US$47.3 million outstanding stock option awards. Malus provisions which are properly crafted can enable such forfeitures. In Wells Fargo’s case, the board also decided to “claw back” an additional $28 million of pay from Stumpf, which had already been paid out to him.
More recently, McDonald’s clawed back US$105 million from the severance paid to its ex-CEO Steve Easterbrook, two years after they had fired him for a consensual relationship with a subordinate which was against the company policy. In August 2020, McDonald’s sued Easterbrook to recoup that payout, claiming he had lied and committed fraud. A subsequent investigation allegedly revealed that Easterbrook had destroyed information regarding his inappropriate behavior, including three alleged additional sexual relationships with employees before his firing. Easterbrook fought the lawsuit before eventually agreeing to the clawback and apologising for failing “at times to uphold McDonald’s values.”
Clawbacks are rare and the McDonald’s board should be applauded for pursuing to claw back what has been paid to its ex-CEO – although a “glass half full” view may question whether the board should have done a more thorough investigation in the first place before paying out the severance.
Speaking of clawbacks, Catalist-listed Asian Micro Holdings’ annual reports over the last few years could well win the prize for the most honest statement on clawback provisions, or lack of, when it said: “The Company does not have any contractual provision which allows the Company to reclaim incentive components of remuneration from Executive Directors and/or key management personnel in exceptional circumstances of misstatement of financial results, or of misconduct resulting in financial loss to the Company as such provisions will stifle the Company’s ability to effectively attract and retain the right individuals”. The right talent may indeed be hard to find.
Copyright for cartoon belongs to Mak Yuen Teen
Termination, ex gratia and other discretionary payments
On 22 December 2021, ASTI announced that Dato’ Michael Loh would be retrenched as CEO but will remain as Chairman. It said he is contractually entitled to a termination payment of S$2.041 million but the Board had decided to only pay him S$1.378 million. The contractual arrangements are of course decided by the board and RC, and Dato’ Loh was executive chairman, CEO and major shareholder who would have a big influence on appointments to the board and RC.
The company said that as the termination payment does not exceed the threshold stipulated under Section 168(1A) of the Companies Act, the approval of shareholders in a general meeting is not required.
Section 168(1) states that “it shall not be lawful for a company to make to any director any payment by way of compensation for loss of office as an officer of the company or of a subsidiary of the company or as consideration for or in connection with his retirement from any such office…unless particulars with respect to the proposed payment, including the amount thereof, have been disclosed to the members of the company and the proposal has been approved by the company in general meeting…”
Section 168(1A) states that shareholder approval is not required “if the amount of the payment does not exceed the total emoluments of the director for the year immediately preceding his termination of employment; and the particulars with respect to the proposed payment, including the amount thereof, have been disclosed to the members of the company upon or prior to the payment.”
By paying Dato’ Loh an amount which is not more than his previous year’s total emoluments, the company would avoid the need to seek shareholder approval at an AGM. However, Dato’ Loh’s total remuneration for FY2020 was S$1,294,000 according to the company’s annual report. This means that the termination payment of S$1.378 million exceeded his previous year’s remuneration and require prior shareholder approval. However, ASTI said that the total remuneration disclosed in the FY2020 annual was incorrect due to a “clerical error”.
It also said that the statement in its FY 2020 annual report that there are no termination, retirement or post-employment benefits provided for in the employment contracts with the Directors, CEO or top five key management personnel, was also incorrect due to an “inadvertent oversight”. It said the board had in fact added a termination clause to his contract in August 2020, which entitled him to an estimated termination payment of at least 20 months of his fixed salary (based on his contractual entitlement of S$2.041 million).
Did the board act reasonably in adding such a generous termination entitlement, especially when the company is struggling financially?
In FY2018, ASTI had paid Dato’ Loh a S$8 million “bonus and management incentive”. It did not disclose how the amount was determined and whether it was contractually provided for. This was later revised to S$2.182 million. The company said that the RC had deliberated the S$8 million bonus that was already approved and paid to Dato’ Loh, after he had communicated his decision to resign. It did not explain why a bonus for FY2018 would be revised when Dato’ Loh’s decision to resign was made in 2019 and was to be effective as late as 7 April 2020. It would appear that the original S$8 million payment should have been approved by independent shareholders, as it was deemed to be an interested person transaction (IPT) and the amount would have crossed the five per cent threshold requiring such approval. Reducing the amount to S$2.182 million meant that it only required disclosure and not independent shareholders’ approval.
At Chip Eng Seng, when its founder, Mr Lim Tiam Seng, retired as Chairman and became Honorary Chairman and Advisor in FY2017, he was paid S$2.4 to S$2.45 million in a “one-off gratuity payment in recognition for his lifelong contributions to the Company”.
At Genting Singapore, the company’s annual reports show total remuneration for the executive chairman increased to between S$21.25 and S$21.5 million in FY2020, from S$9.5 to S$9.75 million the year before. The company subsequently clarified that a significant proportion of this remuneration was an accounting accrual in respect of a S$35 million bonus which was contingent on the company winning the Yokohama Integrated Resort (IR) project.
While the contingent bonus at Genting has since become moot given that the Yokohama IR project has been cancelled, should such a large contingent bonus be paid to the executive chairman for winning the project since he will likely receive higher future bonuses from increases in company profits if the project was won?
Paying an additional bonus for winning a project could be justified. For example, it is quite reasonable to pay a business development manager bonuses for winning new customers or projects. However, paying such discretionary bonuses to executive chairmen or EDs who are controlling shareholders or their family members will inevitably raise questions as to whether RCs and boards can be sufficiently independent in ensuring such payments are appropriate and fair.
RCs and boards have considerable discretion to make termination, ex gratia and other discretionary payments as long as they fall outside the rules requiring the approval of shareholders.
Strengthening safeguards against excessive remuneration
We should consider putting in stronger safeguards for the approval of remuneration of directors and employees who are major shareholders or their family members. In family and founder-controlled companies in particular, relying on IDs who are appointed by the same people whose remuneration they are approving is not going to mitigate the risk of excessive remuneration in such situations.
Unless IDs are appointed by independent shareholders, remuneration in such situations should be treated like IPTs and require the approval of independent shareholders when they cross a certain threshold.
