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Corporate Governance in New Zealand

Principles and Guidelines

ISSUE FIVE: Remuneration

Q: Internationally, there is a trend to explicitly link directors' remuneration with company performance. To what extent do you think this should be the case in New Zealand?

Opinion was divided on whether directors' remuneration should be linked to company performance. A respondent who supported this link commented:

"Directors should be prepared to back their judgement by having "skin in the game."

Some people said it should apply to managing and executive directors. There was no consensus on whether it should apply to other directors. Some said that it should definitely not apply to independent directors.

Some who supported linking remuneration to company performance pointed to risks of creating incentives for taking a short-term rather than a strategic or longer-term view of the company. Other supporters thought remuneration should be linked to the objectives in the annual plan and that this would provide an alignment of directors' incentives and shareholder value. There was a suggestion that any proposal to increase directors' fees be justified by evidence of good performance.

The respondents who disagreed with explicitly linking company performance to director remuneration also emphasised the risk of encouraging short-term thinking rather then long-term planning. It was suggested that a link between remuneration and company performance could undermine ethical conduct.

"Directors are employed and remunerated by the shareholders for the long term based upon a stewardship and fiduciary role and there should be no link between short-term remuneration and company performance. It would be difficult to define performance for these purposes. Performance based upon sharemarket outcomes could lead to short-term decision making."

It was noted that local authorities, such as district health boards, have their directors' remuneration determined by a legislative process.

Q: Do you agree that, in New Zealand, non-executive directors' remuneration is currently set at a level to attract and retain individuals who will make a significant contribution to company performance?

There was a strong view that non-executive directors' remuneration is not currently set at a level that will attract and retain people who can make a significant contribution to company performance.

Some people supported this by saying remuneration was too low for the responsibilities, expectations and risks associated with being a director.

"... given the responsibilities and expectations [fees] are generally too low."

Others said that while it might be acceptable currently, it is generally inadequate to attract the necessary talent for the future. It was noted that some larger public companies are starting to address this issue.

Q: Do you believe there are any circumstances in which it is appropriate for non-executive directors to receive retirement payments?

Opinion was divided over whether there are circumstances in which it might be appropriate for non-executive directors to receive retirement payments. A strong view was this should never occur, but a significant minority supported it. Several said that directors should be paid a total remuneration package throughout their tenure, therefore avoiding the need for retirement payments.

"Depends on the adequacy of the fees. May be justified in some cases. Preferable that annual remuneration is appropriate to avoid this."

Some thought retirement payments were appropriate only where directors' fees were low, and where payment was linked to company performance over the directors' tenure. It was suggested that any payments be assessed on a case-by-case basis and in all circumstances paid only if approved by shareholders.

Q: Do you agree with the view that at least part of a non-executive director's remuneration be 'at risk' on the basis of company performance?

Opinion was divided on this.

Of those who disagreed some said that directors should be paid a fair fee as paid professionals and others raised the issue of needing to avoid creating incentives for short-term decision making. There was also a view that directors' appointments themselves should be at risk based on non-performance. Some said it was important that all directors be treated equally in relation to pay-for-performance incentives.

One comment was:

"Long term there may be some merit, but if it is short term based then no.... as it may lead to decisions being made that are contrary to the company's and its shareholders' longer term interests."

Of those who supported the idea of part of a non-executive director's remuneration being at risk, some qualified this by saying it should only occur within the total remuneration level approved by shareholders. Others said that while some kind of performance-related remuneration is important, it is also important to be clear about what the performance indicators are.

Q: Is it appropriate for a proportion of a director's remuneration to be paid in company shares or in options in the company's shares? If so, should this be expensed against company earnings.

Opinion was divided.

Several people answered "no" to the first question but some of these qualified their opinion by supporting payment in shares but not options, and others opposed such remuneration for non-executive and independent directors. Concerns were raised around compromising judgment, options diluting existing share holdings, and the possibility of abuse. A few said payment in shares creates a conflict that the governance debate is aimed at eliminating.

Where people supported some payment in shares, there was strong support for this to be fully disclosed and approved by shareholders. If directors are paid in company shares or options, there was close to unanimous support for these being expensed against company earnings.

The fact that the treatment of such payments is an unresolved issue in accounting circles was raised.

Q: Some commentators warn that linking executive and directors' remuneration to company performance over one or two years can create a "short term" bias in thinking. To what extent do you think this is an issue in New Zealand today?

A great majority of people saw "short-termism" as an issue when executives' and directors' remuneration is linked to company performance with several saying this was a "real issue" or a "real problem" in New Zealand today.

"I am convinced that this is an issue, particularly in our large public companies."

Others said "short-termism" was a particular problem unless these was a balanced linkage to short-term and long-term strategic performance. The point was made that boards should be able to identify this problem and rectify it.

Of those who disagreed that this was an issue in New Zealand today, some noted it was an issue more with executives than directors. Others noted that the problem was less one of short-term bias than one of poor performance overall and the "inverse relationship" between remuneration and company performance.

Q: To what extent do you agree that the remuneration terms of a CEO's contract and those of senior management, including termination payments should, be disclosed to shareholders?

A majority of respondents agreed that the remuneration terms of a CEO's contract and those of senior management, including any termination clauses, should be disclosed to shareholders. Those offering qualified support suggested reporting in bands or without reference to particular individuals. Others said that transparency of policies was a core issue and more important than disclosure of actual amounts. Some suggested that disclosure of remuneration terms should apply to CEOs but not necessarily to all senior managers.

Where people disagreed, their comments included that present levels of disclosure are sufficient, that personal contracts should be kept private, and that shareholders appoint boards to manage this process.

Q: There is a view that executive remuneration should be directly subject to shareholder approval. Under what circumstances would you consider this appropriate in New Zealand?

The great majority of respondents disagreed with the view that executive remuneration should be directly subject to shareholder approval.

There was a strong view that this is a matter for the board. Some said there was no need, so long as there is transparency around what is being earned. It was noted that directors are better qualified to assess appropriate remuneration structures than shareholders.

Of those people who agreed that there might be some circumstances in which it is appropriate for shareholders to approve executive remuneration, the issue of an executive also being a director and/or a shareholder was raised. It was suggested that this might be relevant in non-performing companies, and also that shareholders should be told of material changes in remuneration policies or levels.

Q: Do you have any other comments on this issue?

Other points noted in relation to remuneration were

• the need to avoid shifting management decisions to shareholders;
• some shareholders could have equally short-term objectives, which could diminish the value of disclosure;
• significant shareholding by an independent director could diminish independence;
• directors and employers must act in the best interests of the company, so ideally at-risk payments should not be required; and
• remuneration should be linked to long-term company objectives.

Several people commented that fees for executive directors are too low. It was suggested that comparisons be made with other professionals who assume a similar degree of responsibility.

Views by type of entity

Representatives of listed companies, professional firms and associations were among those offering the strongest support for linking remuneration to performance.

People from listed and unlisted companies were most likely to identify circumstances in which it might be appropriate for non-executive directors to receive retirement payments.

In response to the suggestion that at least part of a non-executive director's remuneration should be "at risk" on the basis of company performance, people from professional firms and listed companies were most likely to offer a blanket "no".

ISSUE SIX: Risk Management

Q: To what extent do you believe New Zealand boards are adequately addressing the identification and management of risk?

There was a wide range of views on the extent to which New Zealand boards are adequately addressing risk management as part of their governance processes.

Some said that it is (and should be) an area of increasing focus for boards and that risk management was improving. There was a strong view that standards are variable. As one respondent noted:

"Some are doing well, but many are not."

Some people suggested that while some of the largest listed companies have enterprise-wide risk management frameworks, this practice is far less frequent in smaller listed companies and almost non-existent for non-listed companies. Others suggested that the view of risk and risk management may be too narrow if the focus is confined to financial loss and legal compliance.

Some respondents cautioned against adopting a "tick-in-the-box" approach to risk management saying business is by its nature risky and it may not be appropriate to legislate for many types of risks that commercial ventures were likely to face. Some said successful companies would already be managing risk well.

Q: What should risk management policies and procedures to encompass (e.g. financial, market, operational, and environmental risk, delegation of authorities and succession planning)? Do you believe risk management polices and procedures should be published?

The majority of respondents agreed that financial, market, operational, environmental risk, delegation of authorities and succession planning should be included in risk management policies and procedures. Other suggestions included legal compliance, technology and intellectual property, health and safety, delegations and roles, and supplier relationships.

Some respondents thought that risk management policies and processes should be linked to business goals and/or value drivers within a company, and that these policies need to be specific to the business of a company. There was strong support for having risk management policies. However, some respondents said that while the main risks to any company should be identified and assessed and the right management responses put in place, this was not something that should be regulated or prescribed.

Opinion was divided on the need to publish risk management policies.

Some favoured publishing policies or a summary of policies. Some commented that this would improve board focus and accountability. Others noted that these sorts of policies are commercially sensitive and in many instances a source of competitive advantage. Others said that they should be published internally, not externally, and it was suggested that only the critical outcomes for which directors are held responsible be published.

One comment was: "[Risk management policies and procedures] should be published only to the extent that it does not compromise the [entity's] competitive position."

Q: Do you have any other comments on this issue?

The issue raised most frequently was that any risk management policy must be subject to appropriate oversight and review of its implementation. Suggestions for this included monitoring by a board committee, by external or internal auditors, or by senior management.

Several noted that risk management policies must be tailored to the size, structure, and business of an entity. Similarly, risk management was considered important for public bodies, although policies must be appropriate for those bodies.

Some said risk management should be seen as a positive contributor to maximising opportunities for companies, but others warned that too great an emphasis on risk could stifle businesses. There was a strong view that risk management should not be a mechanical "tick-in-the-box" exercise.

Views by type of entity

Representatives of professional firms were more likely than others to suggest there is room for improvement in the way in which New Zealand businesses deal with risk management.