The Agency 'Problem'
The agency problem is a timeless maxim describing how management often have different goals to those of the shareholders for which they work. The current swathe of high profile remuneration centered articles in our press brings this issue into the limelight once again.
Are management using their position at the top of organisations to feather their own nests? In these circumstances, certain leaders are disregarding their responsibility for building long term shareholder value.
Purveyors of governance standards are now starting to interrogate this ‘elephant in the room’.
How do they work in practice?
On reviewing the integrated reports of JSE companies it is evident that significant differences exist between what a company’s strategy is and how it pays its Executives. An example cited in a recent Executive Remuneration Position Paper released by the Institute of Directors makes the point:
One mining company, for example, lists energy and water consumption, CO2 emissions, workforce diversity and socio-political factors as key to creating value over the longer term. However, the measures in the incentive schemes are almost exclusively financial, namely, cost management, growth in earnings-per-share (EPS) and total shareholder return (TSR). This creates the impression that the executives are being asked to do one thing but are being paid to do something else.
IOD Position Paper 7: “Paying for sustainable performance”
So what needs to be done
The problem for shareholders up until now is that they have little power with which to interrogate many of the long-term incentives which are typically structured over 3 to 5 years. While compensation is ultimately the decision of the remuneration committee, this doesn’t mean that shareholders must be passive. King IV Codes on Governance have been strengthened to deal with these issues, however it remains paramount that these ‘internal stakeholders’ (read Company Boards) move from seeing governance as a mere ‘tick-box’ exercise to an outcomes orientated one where principles are applied and explained to shareholders.
Recent coverage of ‘activist’ shareholders taking company Boards to task for their remuneration structures highlights the growing discontent with the ‘status quo’. Such circumstances are further compounded when organisations extend loans to management to finance these schemes. In many current companies, shareholders have experienced a double-whammy with their shares down considerably over the past 5 years. High profile listed companies are not alone in situations like this with non-executive Directors of many unlisted companies starting to take note.
Innovation is key
Another core problem with executive remuneration is the lack of innovation in setting effective remuneration structures. As stated in the IOD’s position paper
“very often, gaps between strategy and remuneration exist because remuneration policies and metrics are designed to first and foremost conform to industry benchmarks”.
Share incentives have largely become a commoditized cookie cutter structure. This needs to change with new structures to better align performance conditions. This continued innovation to share incentives structures should be focused on achieving win:win arrangements for executives and shareholders alike.
The good news
In conclusion, those charged with governance across our economy are starting to focus on changing the current inflexible and expensive share incentive schemes currently being used in South Africa.
Much work still needs to be done in respect of executive remuneration in South Africa. The argument that ‘everybody is doing it this way’ is starting to change, which is positive for all stakeholders in the economy.
If you wish to explore this topic in more detail, please contact us.