Governance and risk mitigation of remuneration plans
For a number of years now, investors have encouraged companies around the world to adopt ESG metrics into their executive incentive plans. The argument is that ESG metrics – that is, metrics tied to concerns around environmental, social and governance issues – will help make companies more resilient and sustainable. It is an argument that has gained significant traction around the globe as the risks posed by climate change move from theory to the lived experience of millions of people, as the psychological and economic costs of gender and racial discrimination mount, and significant financial mistakes and irregularities fill the business press.
In Asia Pacific, many companies are working diligently to upgrade their governance policies.
European companies are being prodded by their customers and governments to focus on environmental and climate issues. In North America, George Floyd’s murder, the #MeToo movement, and the Securities and Exchange Commission’s new rules on human capital disclosures, are pressuring companies to focus on social issues, including gender and racial diversity in the board room and C-suite. In Asia Pacific, while less directly impacted, companies have not ignored these environmental or social issues, and many companies are working diligently to upgrade their governance policies, especially with regard to HR and compensation issues.
This governance focus in Asia Pacific is being driven by several trends, including updates to stock exchange listing rules, regulator pressure and investor concerns.
A number of regional stock exchanges have proposed upgrades to board governance rules, including those in Japan, Singapore, Malaysia, and Hong Kong. The updates are generally focused on several key issues, including:
In addition to the updated listing rules, banking and financial services regulators in Asia Pacific continue to expand and refine how financial services firm are governed, with particular attention given to pay and pay governance issues.
One example is Australia, which is combining its banking and insurance regulators into a single entity and revamping a number of rules that will, for instance, expand disclosure of governance processes and policies, expand the role and responsibilities of the board, more closely dictate how material risk takers and key roles in control functions can be compensated, and mandate longer vesting periods for deferred compensation.
Recent accounting scandals from some high-profile Chinese companies like Luckin’ Coffee, along with continued poor disclosure from many companies in the region have led many investors to become wary of investing in Asia Pacific. As noted above, regulators and stock exchanges are hoping to improve governance, but there is clearly hesitation from many investors to devote money to Asia Pacific due to a perception of poor corporate governance and higher investment risk.
ESG investment funds focused in Asia Pacific doubled in size to US$25 billion in 2020.
Perhaps in response to these issues, JP Morgan reports that ESG investment funds focused in Asia Pacific doubled in size to US$25 billion in 2020. And 57% of investors in the region expect to have “completely” or “to a large extent” incorporated ESG issues into their investment analysis and decision-making processes by the end of 2021, according to an MSCI survey.
Executive remuneration is perhaps the most visible aspect of corporate governance and serves as an important indicator of how the board conducts business, manages company resources, and is aligned with shareholder interests. Due to this visibility, as well as the increased regulator and investor attention on governance generally, boards are working to ensure pay practices and reward outcomes are based on a robust governance framework.
Boards are working to ensure pay practices and reward outcomes are based on a robust governance framework.
As with the adoption of any ESG-related goals, the approach taken by each board should reflect that company’s specific circumstances and support the company’s overall business strategy and objectives.
Some of the actions taken by boards that we are seeing include the following:
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Leading remuneration committees understand that effective compensation program governance is a cyclical process that requires the periodic assessment of all plan design features and processes, and includes revisions to stay aligned with external conditions and company strategy.