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At the December annual general meeting, National Australia Bank shareholders will vote on whether to give CEO, Cameron Clyne, more than $2.7 million if, by 2016, he steers the company into the top quarter of its peer group as measured by total shareholder returns (dividends plus increase in share price).
This comes on top of $1.25 million in short-term incentives, which are also subject to performance hurdles, as well as his base salary (which will be published in NAB’s remuneration report on November 19).
The long-term incentive (LTI) plan, proposed in a document released to shareholders yesterday, comes hot on the heels of NAB posting a $1.1 billion fall in full-year net profit to $4.1 billion, largely due to continuing difficulties in its UK division.
Clyne isn’t the only CEO to have an LTI carrot dangled in front of him. It’s easy to see why such plans are attractive to shareholders and boards. Unlike short-term incentives and fixed pay, Clyne will only be paid the full amount if he successfully revives NAB’s fortunes.
If NAB isn’t in the top half of its peer group – other financial services companies – in total shareholder return from September 2016 to September 2017, Clyne gets none of his $2.7 million LTI.
The better NAB does, the more Clyne stands to receive. In this way, his interests are strongly aligned with those of shareholders.
Long-term incentives have become increasingly popular in recent years. But while they are in principle widely supported, remuneration experts question whether such plans achieve what they set out to do, at least in their most common form.
How can leading companies use such plans to motivate and retain key executives?
Structuring a long-term incentive plan: Tied to what?
In Australia, most long-term incentive plans are tied to a company’s total shareholder returns, relative to a predetermined “peer group”.
However, Michael Robinson, of executive remuneration consultancy Guerdon Associates, questions whether this is ideal.
“It all depends on having a relative peer group – one you compete against for capital, customers, employees and suppliers,” he says. “In Australia, because it’s such a shallow market, you tend to have, if you’re a listed company, only three or four major competitors,” Robinson says.
“To have a lot of reward tied to how you rank against those three or four competitors is quite meaningless to the executives concerned, because it doesn’t really motivate them or help retain them. And it’s not well regarded by external investors either.
“While relative total shareholder returns are a very common measure, it’s probably a waste of money.”
There are only five banks in the S&P/ASX100, underscoring Robinson’s point. The NAB proposal is not entirely clear about which companies Clyne’s performance will be measured against.
There can be other problems with relying on total shareholder returns as a measure of performance.
Dean Paatsch, of corporate governance firm Ownership Matters, uses listed stockbroker Perpetual to illustrate the point. With Perpetual, the amount they earn is a proportion of the returns from the broader sharemarket, he says. “So you don’t want their long-term incentives to look at earnings directly.”
However, there are benefits of rewarding total shareholder returns, Robinson points out. Its objectiveness means it “can’t be fudged”, and it clearly aligns with shareholder interests.
But if it doesn’t motivate executives, it can be a large expense.
Finding alternative measures for long-term incentive plans is difficult, and requires looking closely at what constitutes long-term success for a company. Robinson gives the example of capital-intensive companies, which need to raise a large amount of money to fund their operations. “For those sorts of companies, you could have incentives tied to returns exceeding the costs of capital, for example.”
Paatsch says there’s no “one-size-fits-all” approach to long-term incentive plan. While there are a few things his company hates seeing in such plans, what it does want to see depends on the company and what affects its share price.
“What you try to do is make sure it rewards genuine outperformance. Doing that means taking into account the specific circumstances of the company.”
Paatsch stresses that the measures used for such plans should be objective rather than softer assessments of performance. However, keeping this in mind, it might be appropriate to include things other than financial performance when assessing how well a CEO has done. Two weeks ago, for example, Commonwealth Bank shareholders passed a new long-term incentive package that will see CEO Ian Narev’s pay tied to customer satisfaction surveys conducted by external bodies.
“There’s nothing wrong with turning the dial in that direction,” Paatsh says. “As long as the measures are objective.”
Consideration of non-financial performance hurdles is not common in Australia, even though it is increasing overseas.
How long is long-term?
Another area of contention when it comes to long-term incentive packages relates to what can truly be considered long-term.
Ownership Matters recommends a date at least three years into the future.
The Australian Shareholders’ Association, however, recommends a date four years into the future, meaning it clashes this AGM season with some companies who award such plans on a three-year basis.
The ASA’s CEO, Vas Kolesnikoff, stands by the four-year figure, and says in many cases it should be longer. “For construction companies, which undertake large projects that take years to complete, a long-term incentive should last at least five years,” he says.
“You’d want a similar timeframe for large mining companies like BHP, which are established global conglomerates. It would be at least five years from the decision to explore to develop to sale for these companies, which means CEOs make decisions with long-lasting repercussions.
“Then you’ll have smaller mining companies that are just exploration companies. Their long term is a bit different, so their hurdles have to be different.”
Many companies don’t like to set long-term incentives for retiring CEOs, or set such incentives to coincide with the end of a CEO’s contract. Kolsnikoff doesn’t think this ideal. “Leaders make judgements today that will affect a company way beyond that CEO’s tenure,” he says. “The CEO has to be seen to add value.
“When Ralph Norris left the Commonwealth Bank, his incentives continued on through Narev’s tenure. Over the next few years, he’ll either get a return or he won’t. But he didn’t try to say that once he left, it wasn’t his responsibility anymore.”