Top executive compensation: Is it time for a rethink?

TRADE tensions, political instability, rising inequality and mounting debt levels have cast a dampening effect on growth forecast.

The International Monetary Fund (IMF) expects 70 per cent of the global economy to contract this year and has cut its global growth forecast to 3.3 per cent, the lowest since the financial crisis and the third downward revision in six months.

The local front sees a growth forecast of 2.4 per cent for 2019, a decline from 3.2 per cent in 2018. Investor sentiment paints a similar picture with the Straits Times Index (STI) reporting a 6.5 per cent decline in total returns in 2018 and a gloomy forecast for 2019.

In these challenging times, the focus and scrutiny on both how and how much to pay top executives have become a key bone of contention for both investors and the public.

Remuneration Committee chairs are under increasing pressure to ensure that current executive remuneration structures adequately reflect the present realities of business, whilst still motivating executives to outperform on expectations.

While the pay for performance narrative has been around for a while, its alignment in practice and more importantly its ability to improve performance continues to be debated. Looking at the chief executive officer's pay over the last few years at the SGX Top 30 companies by market capitalisation presents some interesting findings.

CEO compensation is primarily made up of salary, benefits and performance-related variable pay (annual bonuses and long-term share-based awards).

In the past three years, CEO total compensation has gone up by 19 per cent, driven largely by increases in variable pay which make up just over two-thirds of their total compensation.

This is in stark contrast to their shareholders who on average only made around 6.5 per cent in returns, which implies there may be some misalignment to what the executives are being paid for.

While shareholder gains or losses can be impacted by a vast array of reasons, it would appear some of this misalignment is structural. Firstly, the variable pay component is still more heavily weighted towards annual cash bonuses (STI) compared to the longer-term share-based awards (LTI) - ratio of around 2:1.

Two main drivers for that are, one, only 77 per cent of companies have LTI plans in place, even fewer make grants every year, so STI's (primarily linked to company profits) are the primary determinant of variable pay.

Two, even where share-based awards are made, there are minimal or no long-term shareholding requirements on executives which does not drive any longer-term share retention (they can sell their shares and encash gains on any short-term share price upswing).

This is in stark contrast to the Western economies, where CEOs are increasingly required to retain at least three to five times their salaries in shares at all times.

Secondly, while the use of LTIs is still respectable within the Top 30, the figures drop significantly in companies outside of that group. Approximately 63 per cent of the Top 150 companies have an approved LTI plan, yet only around half of them made any grants in 2017.

It is also worth mentioning that companies making LTI grants, in the last five years, on average, returned 1.1 per cent higher dividend yields for their investors and saw three times higher income growth.

Thirdly, there isn't a huge amount of variation in performance measures (KPIs) used in both STI and LTI plans. Some form of company profitability metric is most commonly used along with a less closely governed individual performance scorecard for each executive for STI determination whereas Total Shareholder Return (TSR) is the primary measure under LTI plans. There is little evidence of much tailoring of plans in light of a company's individual circumstances, strategic priorities, industry forecasts, shareholder preferences and linkage to shareholder value creation.

Finally, the current executive compensation structures are arguably too complex and lack focus.

Many of the Top 30 companies have between three to four different incentive schemes across varying time horizons and multiple KPIs (often duplicated) which inevitably result in similar outcomes year-on-year, as it is highly unlikely to outperform all measures in any given year.

Lastly, given the muted performance forecasts and cost-saving pressures, it is important for Remuneration Committees to look at executive pay in relation to their wider employees to avoid creating perceptions of unfairness.

Given the absence of such disclosures in Singapore, simply considering compensation for an experienced professional, we find that the Top 30 CEOs get paid around 60 times more.

The average increase in pay over the past three years for the average employee is around 10 per cent whereas for the CEOs it is around 19 per cent. With CEO to employee pay-ratio disclosures in the West now being mandated, this relationship is very much in focus for investors.

Challenging times make for favourable grounds to shake things up. The time to act is now. What has worked for Singapore companies in the past may not necessarily work in this changing environment and expectations.

Remuneration Committees would do themselves and their stakeholders a huge favour by not just looking sideways at what others are doing but focusing more on where they themselves are headed when reviewing and designing their executive pay programmes.

The writer is head executive of rewards, Mercer Singapore.