SA’s CEOs: rewarded for value destruction?
Can clawback clauses put paid to the practice of rewarding poor executive performance? Or do they simply offer a veneer of accountability and corporate responsibility?
You might have thought events of the past 18 months would have persuaded institutional fund managers to take a firmer stand on executive remuneration. Well, guess what? They haven’t.
With two or three notable exceptions, the large fund managers remain happy to limit their involvement on this critical issue to voting against the remuneration policy and the implementation report at the company’s AGM, content in the knowledge that this is a gesture with absolutely no consequence. The remuneration votes are nonbinding. And in many cases even this mealy-mouthed function is outsourced to consultants.
Even the Public Investment Corp (PIC) — the country’s most powerful fund manager, with about R2-trillion under management — which led the field in challenging executive pay about a decade ago, seems to have lost interest.
More recently its engagement has lapsed into box-ticking.
The PIC didn’t respond to requests for comment for this article. Mind you, the asset manager does have a lot on its plate right now.
Whatever the reality, SA’s powerful institutional investors are keen to appear to be doing something. So now, in a bid to show they really do care about skyrocketing executive pay, they are latching onto a relatively new gimmick: insisting executive pay contracts contain a "malus and clawback" clause.
This clause would, in theory, allow for a portion of bonuses to be clawed back if a company’s performance were to fall short of the expectations built into executives’ generous remuneration packages.
In its 2018 executive directors’ report, PwC waxed almost lyrical about the potential of clawbacks to hold executives accountable. "A properly drafted clawback policy could simultaneously act as both a deterrent that discourages executives from taking questionable actions that are not in the company’s best interests, as well as a punitive measure through which executives are obliged to pay back amounts to the company."
PwC goes on to note that, despite the spotlight on corporate failures, there are few instances in which clawback provisions have been applied.
A year later, most of the large institutions are more insistent. Robert Lewenson, governance and engagement manager at Old Mutual Investment Group, which recently demonstrated robust independence when it voted against Old Mutual’s own remuneration policy, says his company encourages clawbacks, but cautions that they have yet to be tested. "Steinhoff may be the test case," he says.
Steinhoff, of course, has taken the clawback concept a large step further. It doesn’t just want the generous, and occasionally unauthorised, bonuses back from former CEO Markus Jooste and former CFO Ben la Grange; it wants the two disgraced executives to return every cent paid to them.
At the end of June the company filed papers in the Western Cape High Court demanding the repayment of R870m from Jooste and R272m from La Grange.
Some hailed it as an enlightened bid to ensure accountability, others as a cynical attempt to be seen to be doing something.
PwC, meanwhile, appears to have gone cold on the use of clawbacks. In the company’s just-released 2019 executive directors’ report, Anelisa Keke, its editor, acknowledges the rapid growth of clawbacks: "Companies are now expected to demonstrate the contingency plans that they have in place to recover incentives paid to executives who have overseen massive corporate failures."
But little more is said, other than a reference to the difficulty of actually getting anything back.
The list of huge failures Keke might be referring to would presumably include Sasol, Woolworths, Brait, Mediclinic, Famous Brands, EOH, Aspen, Hulamin, Resilient, MTN, Tongaat and Steinhoff, to mention just the very obvious ones.
The problem with clawbacks is that by the time they are implemented, ‘the shareholders have already lost their shirts’
A remuneration analyst at one of the top fund managers says the problem with clawbacks is that by the time they are implemented, "the shareholders have already lost their shirts".
This will certainly be the situation at Steinhoff, where legal action is expected to take several years. "But they can have a useful psychological impact," says the analyst.
Even as institutions insist on clawbacks being included in remuneration or employment contracts, they express concerns that the tax implications could make them extremely difficult to implement. For example, could a prior taxed transaction be undone? And what would happen to tax paid on a bonus? (The easiest solution, of course, would be to delay the payment of bonuses for several years.)
To the cynics, of whom there are many, it’s as though institutions are embracing clawbacks because they know they won’t work — virtue-signalling to the millions of investors and workers whose money they are ostensibly protecting.
Opportune Investments CEO Chris Logan believes clawbacks can be implemented before too much damage is done. But, he says, "they need the concerted support of all the major shareholders if they are to work".
Logan speaks with some authority on the matter. In November 2015 he was instrumental in securing the repayment of R7m in bonuses paid to the CEO and CFO of building supply business Distribution & Warehousing Network, or Dawn. To date it is the only known clawback from executives of a JSE- listed company.
"The whole way of giving incentives to executives is fundamentally flawed, as the rewards are usually based on misaligned metrics like ebitda [earnings before interest, tax, depreciation and amortisation] or ebit [earnings before interest and tax], which ignore key factors like the cost of capital," says Logan.
This generally ends badly, and potentially even in an adversarial relationship between shareholders and the executive, he says. "A case in point would be Mediclinic, where, by the time 58.5% of minority shareholders voted against the pay resolutions, 70% of the share’s value had been destroyed and the executive had changed."
It would be difficult to find an environment better suited to enabling a group of elites to enrich themselves than the one that prevails at the listed end of the corporate sector.
With one or two notable exceptions, it seems the fund managers and a slew of well-paid advisers, who are supposed to act as a restraining force on behalf of the millions of individuals whose savings and pensions they oversee, do not care.
Essentially, the CEO appoints the directors, who then feel beholden to him or her for what are increasingly generous board fees. There’s little to no chance they’ll offer much challenge on any issue, let alone CEO pay.
Look closely at the corporate disasters of the pasts 18 months and you will spot a CEO who was allowed to dominate the board.
The CEO also happens to be the person who signs off on the remuneration consultants’ fees, so there’s not likely to be much challenge there.
PwC is one of the largest remuneration consultants in the country. But its latest report, despite its robust veneer, is devoid of any incisive data or challenging analysis, and is symptomatic of the "consultant" problem.
Then there are the auditors, who confirm the accuracy of the figures used to justify high pay levels. They have a tradition of working hard to cultivate their relationship with the CEO, who signs their cheques.
And, finally, there are the International Financial Reporting Standards, which are increasingly criticised for allowing executives too much judgment.
There are no consequences, says Bishop Jo Seoka, chair of Active Shareholder, a not-for-profit company that helps socially responsible shareholders exercise their company rights.
"Corporate executives do as they please. People in power are not taking responsibility and we are not holding them to account," says Seoka, who believes the public must be made more aware of what is going on.
"It’s immoral for people not to take responsibility."
Frustrated by the lack of consequences, Active Shareholder now votes against the reappointment of members of the remuneration committee on boards where there has been the double whammy of value destruction and bonus payments.
"There is increasing sensitivity to the issue," says Seoka. "We can make change[s]."
Remarkably, Active Shareholder’s strategy is unique. With the exception of Steinhoff, where there has been a culling of the supervisory and management board, shareholders have generally been happy to re-elect directors who endorsed eye-watering payments to value-destroying executives.
Aeon Investment Management’s Asief Mohamed dismisses the argument that executives have to be rewarded generously because talent is scarce. Top-notch payments are often made in the belief or hope they will result in top-notch performance. The obvious rejoinder is the recent absence of evidence of that talent.
"It’s nonsense to be constantly threatened with the prospect of [executives] ‘jumping ship’," says Mohamed, who believes nomination and remuneration committees should include younger people who are free from the biases of older people.
Mohamed was also irked by the recent Mediclinic AGM where, despite the hefty vote against the remuneration policy, there was little shareholder engagement.
"Either the shareholders don’t care or they’re engaging behind closed doors," he says, adding that such private engagement is largely ineffectual.
What it means
A move from total shareholder return to economic value added may allow for a more accurate measure of executive performance
The good news for Logan is that the latest post-clawback "gimmick" is something close to his heart. PwC’s report asks whether "‘economic value added’ [EVA] is a more suitable primary financial performance metric".
Proponents of EVA — the profit generated after the cost of capital is taken into account — argue that it creates a simpler and more factual alignment with "real" or "economic" value added, and is not confused by accounting technicalities.
"The factors influencing EVA are considered to be less manipulable by ‘creative accounting’ and more controllable, as well as taking into account the ‘psychology of pay’," says PwC.
The growing acceptance of EVA within the "remuneration industry" may have more to do with the recent sluggishness of share prices and dividends — which are behind the traditionally used metric of total shareholder return (TSR) — than the realisation that TSR could be growing while shareholder value is being destroyed. Just ask the Tongaat shareholders.
Not everybody is persuaded. The remuneration consultant at the large fund manager says EVA is a poor measure for resource companies: "It is generally complicated and involves a lot of executive judgments."
Logan dismisses these objections, saying EVA is one of the very few metrics that cannot be embellished if underlying shareholder value is actually being destroyed. "If done properly, it cannot be manipulated," he says.
While EVA holds out some promise, it seems executive remuneration remains an area in which crises are wasted.
And for that we can thank our large fund managers.