An evolving landscape

The recent global financial crisis has placed executive pay under the microscope. Déjà vu? In the not too-distant past, Sarbanes-Oxley rules were introduced following the failures of giants such as Enron and WorldCom. Executives of failed firms were blamed for taking excessive risks and their behaviour was linked to how they were rewarded.

Though Singapore has been relatively unscathed by the latest crisis, it is timely for companies here to review the risks inherent in pay plans. Reviewing the pay-related information found in the 2008-2010 annual reports of the 50 largest SGX-listed companies, Towers Watson has found several risk-prone areas.

Here, we briefly discuss three areas:

1. CEO Pay Structure

The CEO of a large listed company typically receives three-quarters of compensation in variable form. Of that, the annual bonus, which represents payment for performance over a twelve-month period, has been significantly larger than the long-term incentive. Such a pay mix does not align with the role of a CEO. With few exceptions, the long-term incentive component should be larger than the short-term equivalent since the CEO should ensure sustained company performance over the long-term.

2. Total shareholder returns

Performance shares are rising in popularity in Singapore. Over two-thirds of companies which have performance shares use total shareholder return (TSR) as a performance measure. Intuitively, relative TSR is a good measure. It minimises the effects of market cycles and allows companies to reward executives for outperforming the competition.

However, relative TSR is far from a panacea – it hosts a number of fundamental flaws. First, relative TSR methodology provides no peer group of sufficiently similar or relevant companies. The flaw is magnified in countries like Singapore where there are few players in the same industry.

Another concern is that virtually all performance share plans in Singapore are three-year plans. Research studies have shown that relative TSR over three years does not usually reflect anything other than changes in investor sentiment towards companies. Though a five-year TSR is more meaningful, five years is a long time compared to many executives’ actual tenure these days.

3. Expertise in remuneration committees

The Code of Corporate Governance 2001 requires at least one member of the Remuneration Committee (RC) to be knowledgeable in executive compensation, while the prevailing code states, “if necessary, the RC should seek expert advice”. We think RC members need not be compensation experts but must be equipped to understand the mechanics, costs, benefits and risks of compensation decisions. While we recognise some companies do seek expert advice, companies have not been reporting the use and name of consultants, making it difficult for shareholders to assess if sufficient expertise has been applied.

In conclusion

As an increasing number of Singapore companies evolve into regional/global players, these challenges will be even more apparent with the mix of investors and shareholders being more global in nature. We are, however, confident that the state of executive pay and corporate governance in Singapore will evolve to match the globalisation of companies.

About the author:

Kevin Ong is Director of Executive Compensation for Towers Watson, Southeast Asia