Providing the right motivation and rewards for the economic upturn

In this issue, answers to:

• What are the forces shaping executive remuneration in Asia?
  
• How are organizations in Asia shifting towards a pay-for-performance culture?
  
• What are the key considerations to 'perfect' your LTI plan(s)?
  
• How are organizations in Asia approaching performance measure goal setting?

The global economic crisis hit Asia to varying degrees in 2009. In the aftermath, Asia’s recovery appears to be occurring at a much faster rate than predicted. Despite uncertainties in Europe, organizations in Asia are repositioning themselves for the upturn with some bracing themselves for the talent challenges unleashed by the resurgence of economic growth. Corporate boards are under pressure to deliver improved shareholder returns as well as manage the potential escalation of executive remuneration costs that are associated with retaining and attracting dynamic leaders. Against this backdrop is the heightened focus on governance as well as intense public scrutiny on boardroom behavior.

In this issue of Perspective, we have drawn on our surveys and consulting experience to discuss the executive remuneration challenges that organizations are facing. We then provide a guide for developing effective and defensible executive remuneration programs. Organizations are currently faced with the twin-challenge of developing programs that will not only drive motivation and retain key executives but effectively deal with the risks of uneven or unexpected economic results. Boards will have to achieve under intense public scrutiny.

1. Forces shaping Executive Remuneration in Asia
According to our surveys, during 2009 organizations tried to contain costs by freezing or reducing executive base salaries and giving out lower bonuses. Asia, which avoided many of the severe excesses of executive remuneration seen in some Western, has no major need for dramatic salary cutbacks. There are, however, numerous aspects of Asian executive remuneration that need attention. They include:

• The likelihood of higher retention risk. A “V-shaped” global recovery is probable despite some dark clouds remaining on the horizon (e.g. the bust-up in the Greek economy). In the event the economic recovery gains momentum, retention risks will far outpace the speed of economic recovery.
  
• Global talent demand will rise. Asia’s share of world manufacturing GDP is expected to grow strongly to over 45 percent by 20151. Global competition for top talent is expected to keep the pressure on organizations to deliver enhanced performance.
  
• Pressure to return on raising base salary for talent. Although Asia’s immediate threat from an aging population is less intense compared to Western economies, there will be supply shortfall on key talent. Asia’s high growth forecast will put pressures on executive remuneration costs as will barriers to cross-border talent movement. Our recent surveys show substantial increases in base salary in 2010.
  
• Call for greater transparency. Although interventions on executive remuneration from institutional shareholders and governments have been less intense in Asia compared to Western countries, stakeholders will be demanding more disclosures on executive remuneration decision processes.
  
• More independent reviews from boards. The global banking crisis has led regulators to issue guides and best practice codes in structuring executive remuneration. The G20 has issued global compensation standards for financial institutions. Due to increased public scrutiny, we are seeing a shift in the board’s (remuneration committee) accountability from high-level oversight of the business and general executive remuneration matters to independent reviews and more direct involvement in decision making.

All in all, designing an effective and justifiable executive remuneration program requires different perspectives and has become an increasingly difficult task for many organizations.

2. The Diversity of Asia
The economic strength and prospects of Asian countries differ substantially as do corporate law, tax requirements and the impact of government regulations. The different influences affecting Asian executive remuneration include:

• Local guidelines linking executive pay levels to the average employee’s salary multiples.
  
• The Companies Act in Japan, for example, hampers the issuing of restricted stocks for executives.
  
• In some countries, there is delayed implementation of expensing options.
  
• The emphasis on team cultures and egalitarian cultures means pay differentiation may not be preferred in some countries.
  
• Asian family owned companies tend to favor bonuses rather than equity-based long-term incentives.
  
• In parts of Asia, state-owned companies tend to prefer particular performance measures. Examples include Singapore where economic profit measures are more common; and China, where the State-owned Asset Supervision and Administration Commission (overseer of state-owned enterprises) prefers return on equity and economic profit measures.
  
• Varying individual income tax implications. In Hong Kong, for example, taxation rules generally favour option grants as taxation can be deferred until exercise, whereas in many countries taxing occurs at the time of vesting.

3. Bonus Plans
A recent Mercer survey indicates that short-term incentives (STIs), or commonly referred to as bonus plans in Asia, are the most important and effective pay element for aligning remuneration to organization strategy3. To avoid the key underlying concern over “fat cat” pay, pay-for-performance programs need to demonstrate that the executives do contribute to shareholder value creation.

Results from Mercer’s latest Annual Asia Executive Remuneration Snapshot Survey4 (Mercer Survey hereafter) indicate that Asian organizations intend to increase their STI target opportunities for executives. Of the over 230 companies polled, 39 percent plan to raise their target STI opportunities compared with only 21 percent of the respondents polled in 2009.

The shift towards STIs is consistent with a pay-for-performance culture that has emerged quickly and is fast becoming more entrenched in Asia. India’s CEO pay growth rates have been high, but until recently the growth has been mainly in the form of guaranteed cash and perquisites/benefits, which are more likely to impact industry competitiveness. Improved pay-for-performance models are needed to address shareholder’s concerns of having a reasonable proportion of pay “at risk” and to support the attainment of key shareholder goals.

The following chart provides an indication of the planned changes in target STI levels. In almost all Asian countries, levels of pay are expected to be markedly higher than they were last year when on-target performance is achieved.



Organizations relying on STIs to reward executives for performance need to be aware of the inherent risks that come with a remuneration package skewed towards STIs. In markets such as China where STIs account for a significant portion of annual cash remuneration, but where the economy is relatively unscathed by the global downturn, increasing the STI target opportunities may create windfall compensation for executives.

4. Long-term Incentives
The Mercer Survey shows that while organizations are not rushing into making changes to long-term incentives (LTIs), recent indications point to greater willingness to review their LTI plans, possibly due to the speed of recovery, improved capital markets, and the changes in the regulatory environment.

The significant falls in stock markets in late 2008 and 2009 made LTIs a lot less appealing, although grants made in 2009 at lower prices will offer significant future upside. Asian organizations tend to only have a single LTI plan in place (see Table 1 below), usually an option plan. The value of executive packages and their retention/motivational value may have been significantly depleted due to the declines in the stock market where options are a significant part, or the only part, of the LTIs provided.



It is therefore very important for the Remuneration Committees to assess the current LTI value and the impact on both motivation and future retention to build stronger links between pay and business strategy. “Perfecting” your LTI plan(s) may involve:

• Reviewing the objectives of the LTI plan during times of change. Bear in mind it is difficult for a single plan to achieve tough performance goals as well as offer strong retention value.
  
• Considering other LTI alternatives to meet the business needs. For instance, an organization might consider a cash-based LTI plan for executives who have limited impact on the company’s stock price or if the company’s stock price is driven more by industry and exogenous economic issues than by its own performance. Although cash-based LTI plans are widely used amongst unlisted organizations, our survey reveals that some listed organizations (25 percent) have offered long-term cash to executives.
  
• Avoiding focusing on only the bad and the ugly sides of stock options, so much so that their benefits in driving growth and value creation are overlooked. Abuses in the past mean stock options are not popular with corporate governance organizations. A key concern too is that executives only have an upside and dilution is relatively higher.
  
• Introducing performance-based plans (e.g., performance shares, performance units, etc.) which have been gaining momentum in Asia, particularly in China where over 80 percent of equity plans have financial performance conditions on vesting, and the listed SOEs are mandated to have vesting financial performance conditions as well as financial performance conditions for grants.
  
• Using bonus banks and deferred annual bonus plans to address problems with setting longer-term performance goals. These can be aligned with risks and executives can share some of the downside. They have yet to gain popularity in Asia, except in Singapore where bonus banking is more common, and in China where deferral is mandatory for executives at SOEs. In this way the line between STIs and LTIs is becoming blurred.

5. Selecting Performance Measure
Growth, profitability and returns contribute directly to the creation of economic value (aligned to the shareholder experience) and form the basis of Mercer’s performance measurement framework. Capturing the right metrics for each company is the most important challenge in designing and implementing an effective executive remuneration system that pays for results. To decide on the metrics, firstly consider what other companies in the industry or sector use as measures. This is where cross-border research can be valuable in Asia. Secondly, consider the metrics used by analysts and other external sources to evaluate the company to ensure alignment with the share price. Finally, the measures need to be sufficiently simple and familiar to be understood by all the executives involved – if a complex measure such as economic profit is to be used, there may be a need to train executives to understand the drivers. The choice of measures should involve qualitative and quantitative investigation.

Goals (calibration) to link pay to the metrics needs to be challenging as well achievable. During times of turbulence and growth, such as has been common in Asia over recent years, it is difficult for the Remuneration Committee to find a balance that is fair to all parties. Mercer’s experience is that organizations should approach goal setting from three perspectives:

• Internally-based, with absolute targets based on budgeting and strategic planning or other company-specific standards (e.g. the cost of capital).
  
• Externally informed, with internal targets shaped by information on competitor’s performance, shareholder expectations, or other external considerations.
  
• Relative comparison, that involves setting performance targets in comparison to peers. The limited number of peer companies can make this challenging in many Asian geographies, unless peers are selected from more than one country. However, the relative performance measures have gradually received more attention, for example relative performance is a mandatory performance condition for any equity plans of listed SOEs in China.

In setting the metrics, focus on a range of performance parameters that will reflect the many facets of performance success in your organization, including financial and strategic success as well as short- and long-term success. All pay-for-performance plans, especially bonus plans, should include a healthy mix of financial as well as non-financial measures. Balanced scorecards have gained popularity amongst many local companies in Asia and this can be an excellent tool for planning. This does not mean that organizations should incorporate all the scorecard goals for the incentive plan, as this will usually mean that the level of focus on the critical metrics for increasing value will be diluted. Similarly it is common to use an “unbalanced” scorecard to ensure sufficient focus on the financial viability of the organization.

The Mercer Survey shows that most companies use a balance of measures for the STI plan with a strong focus on differentiation based on individual performance. The following table shows differences by geography, with Japan and South Korea less likely to include an individual measure. It is more common to see companies in the emerging markets such as China and India using revenue/sales growth-based measures than elsewhere.



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