The importance of fair and transparent remuneration January 2020

Derek+berry

The issue of executive remuneration seems to come into the spotlight every few months, like when Westpac's CEO departed following the reporting scandal and was set to pocket $2.7 million in compensation. In an unrelated case, IFM Investors are receiving parliamentary pressure to reveal remuneration for top execs.

These and other cases raise questions around what constitutes "fair" remuneration, and the value of balancing transparency with confidentiality and secrecy.

Global risk advisor and consultancy Willis Towers Watson recently appointed a new remuneration specialist, Derek Berry, to help businesses better understand board, executive, and non-exec remuneration strategies. He answered our questions about setting remuneration rates and disclosure expectations.

How do you qualify “fair” compensation?

When the pay levels for employees in the same roles within a company are paid at equivalent levels, after allowing for each employee’s performance and depth of experience, I believe remuneration is fair. Both the employee and the company should feel that the remuneration is fair for the employee’s contribution to the organisation. Also, the company should ensure that its approach to remuneration is fair relative to the market in which it operates.

What’s the process of determining remuneration?

When a company decides on a remuneration and broader rewards strategy, it may be formally documented or informal. A strategy should take account of the company’s circumstances and how it competes for talent, which determines a number of factors:
• the structure for remuneration (e.g. mix between fixed and variable)
• relevant market (e.g. business banking)
• desired market positioning (e.g. median for base salary)
• performance linkages (e.g. what may cause someone to get no increase or bonus)
• internal structure (e.g. grading/level)
• how the annual budgets for fixed and variable remuneration are set.

Based on the strategy, individual managers typically make remuneration recommendations at the time of hire or remuneration review using the strategy and any tools provided by the company. The recommendation is then usually approved by the next level manager (or board for executives).

Do you believe there should be more transparency around remuneration in businesses, beyond the executive level?

Yes. More transparency increases employees’ understanding of their reward arrangements, which increases the likelihood that an employee will feel that their remuneration is fair. An acceptance that pay is fair is often linked to higher levels of employee engagement.

When increasing transparency, it is important that managers are provided with training, tools and support to have effective conversations with their employees. Otherwise the impact of increased transparency may be negative.

There’s been a pushback by IFM against revealing remuneration of people like fund managers. Why would a company want to keep that information secret?

I can’t speak in terms of specific organisations, but a common belief is that revealing remuneration details leads to pay inflation – this is very difficult to prove or disprove because it is so hard to isolate the variable. The argument “for” it being inflationary goes along these lines:
• Most employers do not want to be seen as paying below the market, so if remuneration data is generally available, then the lower paying companies are likely to give larger increases at the next remuneration review
• Most employees do not want to be paid in the lower half of the market, so if that point is readily available, the employees will have a stronger case for a larger increase.

In addition, some high-paying organisations may be reluctant to reveal remuneration arrangements that may be regarded as very high by general community standards.

In November, the APRA chair said that there was angst in business coming from the regulator’s proposals to overhaul banker remuneration. Why do you think that is?

Some of the potential reasons include that APRA’s proposal for more emphasis on non-financial incentive targets is not shared by all the proxy advisors, thus creating tension for the banks to obtain shareholder approval for the Remuneration Report at the same time as aligning with APRA proposals. Also, identifying rigorous and reliable non-financial measures that do not have unintended consequences is difficult.

APRA wants longer deferral periods for incentive awards. Studies have indicated individuals place a heavy discount on the perceived value of deferred payments and the longer the deferral, the larger the discount. Also, the timeframes for senior executives who have remained in a role are often less than the deferral period and many of these changes are driven by the company rather than the individual, so the executives may not feel there is alignment.

How do you incorporate things like financial metrics and the size of an organisation into account when determining appropriate remuneration?

The size of an organisation can be a significant factor indicating the complexity of managing it; there are clearly other factors affecting complexity, but they can be more difficult to compare, so size is a common proxy. Pay is linked to the complexity and scope of a role.

Financial metrics are important when determining the affordability of reward programs and therefore influence remuneration. They are also more clearly measurable and provide a more structured base for determining variable remuneration than non-financial metrics. Other considerations:
• Using financial metrics for executive remuneration creates some alignment consistent with Agency theory
• May provide a basis for success sharing where a company wishes to incorporate in the reward offer (e.g. as basis for determining whether to make awards under an employee share plan)

Does disclosing remuneration dissuade future employees from joining an organisation? And, how can organisations retain confidentiality at a time when there is increasing governmental and public pressure to be transparent?

I don’t have any evidence or basis for commenting on disclosure in terms of dissuading future employees. If an organisation’s general remuneration was so negative as to have that impact, then in my experience this would already be the subject of some knowledge for potential employees (e.g. comments in Glassdoor).

Disclosure for public companies is required at Key Management Personnel level. I think the main drivers that will make it difficult to retain confidentiality are:
• The goal of organisations to increase transparency so employees better understand and engage with the reward offer
• Potential for legislation along the lines of some US states. Part of this driver has been to reduce pay inequities and there does appear to be some evidence that it may help. At the same time Australia’s larger employers already allocate considerable time and attention to minimising bias for equivalent roles.

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