“When we own portions of outstanding businesses with outstanding management, our favourite holding period is forever.” –
By: Guy Addison – Managing Partner at Addison Advisory Incorporated
1 November 2019
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 centred 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, there appears to be a complete disregard for building long term shareholder value. It’s high time that purveyors of governance standards start interrogating this ‘elephant in the room’.
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 the most 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”
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.
In addition to poorly performing equity markets, new legislation, most notably Section 8C of our Income Tax Act, has added further drains on the effectiveness of current share incentive structures. All gains arising under employment-linked share incentives (whether options or share purchase schemes) are taxable as income. Taken with the recent increase in the marginal tax rate to 45%, Companies are awarding greater tranches of shares to Executives to compensate for this increased ‘cost’. In effect, ordinary shareholders are paying the price.
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 commoditised 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.
In conclusion, those charged with governance across our economy should 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 being questioned.
The answers will surely be of interest to all of us.
This article first appeared in the Institute of Directors Magazine: Directorship – January 2019
Guy Addison is a corporate finance professional. He works with high-potential businesses on share transactions and structuring investments.
For further information:
Addison Advisory Inc.
Telephone +27 (0) 10 005 3277