Asian firms focus on variable pay for executive compensation

Fewer long-term incentive programs, despite fierce competition for CEOs
By Fermin Diez, Hans Kothuis and Jiawen Chua
|Canadian HR Reporter|Last Updated: 07/17/2012

In Asia’s rapidly evolving economies, there aren’t many certainties or lasting trends, yet one thing remains constant: An organization’s talent is vital to its continued growth.

Retention is one of the top three executive talent issues for most companies and this concern is increasing, reflecting the fierce competition for talented leaders among Asian organizations.

The notion of human capital as an investment to be cultivated — as opposed to a bottomless resource that can be tapped on demand — represents one of the most significant shifts in business thinking in recent years. In boardrooms around Asia, it has become increasingly accepted that successfully competing for human capital is as important as competing for market share. In fact, it could well be retaining talent is harder than retaining clients.

Human capital risk ranks fourth out of 11 risks in terms of potential business impact, according to 2011 Conference Board research in the United States. And when the Economist Intelligence Unit asked risk managers to rank 13 key risks, human capital topped the list. Effective human capital may become the single most important driver of long-term financial success and shareholder value creation.

The dilemma of paying for performance or paying for retention leads to some compelling questions about executive pay programs and the pay-for-performance philosophy:

• Is executive pay aligned with shareholder value creation?

• What is the proper role of equity in a compensation program?

• What objectives should compensation committees at Asian-listed companies pursue: To attract and retain executives or deliver pay for results?

• How can companies differentiate between outstanding, average and below-average performers and ensure they still retain key executives?

• What should be the time horizons for both individual and corporate performance assessments, as well as wealth creation over the course of an executive’s career?

Common practices in executive rewards in Asia

Market competitiveness: Given the high priority placed on talent, it’s no surprise there is a low supply of qualified, experienced, multicultural and capable CEOs in Asia. This top talent can demand a higher wage and, therefore, companies have to be willing to pay more to get a higher calibre of talent that can deliver the results shareholders expect. Otherwise, this talent is likely to go to the highest bidder.

Executive pay in several countries in the region (such as Singapore, Hong Kong and, increasingly, Japan, China and India) is fairly transparent. This allows boards to determine the competitive pay levels for the talent they seek to attract and retain in terms of fixed salary, annual bonus and long-term incentives, along with other executive benefits.

The most difficult decision a compensation committee needs to make in this respect concerns the group of companies to choose for appropriate comparisons. This is not so straightforward in Asia as there are a limited number of large organizations within the same industry in each country (for instance, Singapore has only three locally listed banks), making comparisons more art than science. Many remuneration committees opt to choose companies of a similar size, even in different industries, under the premise a CEO in one industry could be poached by a company in another.

Another area of concern regarding market competitiveness relates to pay mix. In Asia, companies provide a greater amount of variable pay than their counterparts in the West. The fact the fixed pay element for Asian companies has fallen from 60 per cent in 2009-2010 to 41 per cent in 2011-12 highlights this trend: Asian companies prefer more flexible pay structures that can be adjusted — up or down — based on business performance.

However, it is also important to note Asian companies generally are less prone than their counterparts in the West to provide long-term incentive programs to executives. When companies in Asia provide variable pay, they are more likely to use cash than shares.

There is perhaps less willingness to dilute the shares of a company in Asia. However, this trend should wane as more Asian companies become global. For instance, AIA, a large insurance company headquartered in Hong Kong, has long-term programs aligned to global market practices.

Key performance indicators (KPIs): For an organization to develop a successful pay-for-performance program, it must have a clear idea of objectives. Without such clarity, it is difficult to identify the type of performance that should be rewarded or link performance to compensation.

Aligning pay to performance requires proper calibration of compensation programs to ensure the levels of pay delivered are in line with levels of performance actually achieved. In Asia, profits and total shareholder return are the most used KPIs in share plans.

Profit-based measure most prevalent: Companies often use a combination of internal financial metrics with external validation of performance against peers in their pay programs. Such external calibration is often both retrospective, to assess how the company actually performed compared to its competitors, and prospective, to ensure performance targets include an appropriate degree of “stretch.”

At the end of the year, a well-aligned program with a rigorous performance evaluation process means little if individuals are not held accountable for meeting agreed-upon goals. While this notion of black-and-white results is common, 41 per cent of Asian companies also use non-financial measures in their incentive plans, according to Mercer’s 2011-12 Asia Executive Remuneration Snapshot Survey.

This can take the shape of a formal balanced scorecard, in which performance is evaluated in specific areas such as people management, customer satisfaction or process improvements. These measures can give a more appropriate picture of overall performance than rigidly adhering to a single financial metric such as return on equity.

Striking the right balance: In Asia, annual incentive plans are commonplace but many companies also have multi-year plans to ensure key executives do not lose sight of longer-term objectives.

Asian companies are moving away from stock options to other types of plans as the use of stock option plans can lead to retention difficulties in a volatile market. Instead, these companies use more restricted shares to aid retention and connect pay to performance.

Good practice suggests an executive’s pay should have both fixed and variable components. The fixed component is designed to pay a competitive wage for the accountability of the position and the variable component should be linked to both short- and long-term performance periods. These are common practices in Asia and, in addition, there is a greater use of long-term incentive plans for retention purposes. Companies often have more than one plan to balance a need for performance with a need to retain executives.

Corporate governance: Shareholders have a right to know the financial decisions a company makes and executive remuneration is effectively an expense that should be disclosed in more detail. Several countries in Asia have made strides in the direction of greater transparency, partly spurred by the Financial Stability Board’s guidelines for financial institutions.

Variations of these good corporate governance practices have been adopted by Hong Kong, Singapore and other countries and have had a spillover effect on regulators and boards alike of organizations in other industries.

Disclosure leads to greater information that helps regulate and control pay, but it has the side effect of potentially inflating pay, as nomination committees find they need to go beyond median levels of pay to attract CEOs.

Publicly listed companies in Asia generally understand the need for aligning pay to long-term shareholder value creation, yet they temper it with an equally strong need to retain good talent. And they also balance the shareholders’ view that quarterly earnings matter with a long-term perspective. As corporate governance guidelines are honed around the region, the trend towards more responsible executive compensation will continue.

Fermin Diez is a senior partner and Asia Pacific business leader for human capital consulting at Mercer. He is based in Singapore and can be reached at fermin.diez@mercer.com. Hans Kothuis is Mercer’s Asia Pacific leader of rewards consulting based in Hong Kong. He can be reached at hans.kothuis@mercer.com. Jiawen Chua is a consultant in Mercer’s ASEAN human capital consulting team based in Singapore. He can be reached at jiawen.chua@mercer.com.

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