This is the time of year when many companies have reported results for the previous year and have sent out their reports and accounts to be approved by shareholders at forthcoming AGMs. Remuneration reports usually get most attention and are always going to be a sensitive topic, but it sometimes seems as if directors are deliberately trying to provoke shareholders to react by the scale of their rewards which, increasingly, are dominated by bonuses and usually paid in shares.
Few people would argue that the interests of executives should not be aligned with those of the owners of the business and making executives shareholders achieves that. However, blurring the distinction between the two can create conflicts that may be counter-productive.
Although it might not always seem that way executives are appointed by the shareholders to run their businesses on their behalf. The interests of the owners (typically pension funds) are clear. They want a business that will thrive and grow over the long term, i.e. many decades. In contrast executives, the appointed agents, rarely stay in the top job for more than a handful of years, if that. So there is a big discrepancy in the time horizons. That is fine when the principals clearly instruct the agents on how they want the business run and pay them accordingly.
However, increasingly the remuneration policies seek to blur that distinction by doing everything to encourage the agents to be more like the principals by giving them free shares as part of their bonus packages. Even worse, there is a rising trend to make those bonuses dependent on the total shareholder return (TSR), albeit over a few years. That compounds the incentive of executives to do something in the short-term that will increase the share price. Yet, as most market observers know, share prices and equity markets respond to a whole variety of factors. Indeed, incentivising CEOs by targeting TSR implies they can control share prices. That is something the FCA surely cannot wish to encourage.
There are ways to beef up share prices but they all have consequences. The most obvious is to increases earnings per share, which these days are almost invariably defined as adjusted earnings per share and that gives ample scope for the adjustments to be favourable to the agent doing the adjusting.
Another way to boost…
Interesting commentary Rob.
I think, perhaps, it is important to distinguish the benchmarks against which management are assessed and the currency in which they are paid.
As shareholders, I think it is good to align management's long term interests in maximising shareholder returns through dividend payments and capital gains. Paying them in shares achieves this as it gives them a direct long term interest (especially if they are locked in with vesting periods etc..). Personally, I am quite happy for management to be paid in the currency of shares but less happy for them to be measured against hitting a (usually short term) given share price performance target. I recall the stink earlier this year when the senior management at Tristel (LON:TSTL) triggered a generous LTIP put in place last summer immediately prior to a weaker than expected earnings statement. Even if there is a reasonable explanation for this kind of thing (as in this case I believe there was) it can lead to investor ill feeling and a sense that management has in some way been underhand.
As you say, there are numerous short term fixes that can bolster a share price to trigger an LTIP payout without this necessarily being for the long term benefit of shareholders. For the management involved, there is a risk that it is better to fudge the numbers to by gearing up the balance sheet to receive 10,000 shares worth 50p in a year's time than miss a target and receive zero shares that are worth 100p over the same period - half a cake is better than no cake even if the cake ends up being smaller than it should be.
The hard part then is to design a clear and objective benchmark to measure management against that is consistent with long term shareholder benefit without creating an incentive to game the system against wider shareholder interests. I agree that fixing on a single measure such as share price or EPS doesn't seem to do it but what exactly the right measure should be seems to be a bit of an elusive Holy Grail for most companies.
