Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 335

APRA's executive remuneration changes are unwelcome

Australian Prudential Regulation Authority (APRA) is proposing to change remuneration requirements by de-emphasising the role that objective financial metrics play in determining executive compensation.

While well-intended, we believe the changes will have unintended negative outcomes which impact both investors and the wider public. We recently made a submission to ARPA outlining our concerns. We believe that rather than the proposed caps on financial performance metrics, 'active ownership' will ultimately see better outcomes for all stakeholders.

Background to the proposed changes

On 23 July 2019, APRA released for consultation a discussion paper, “Strengthening Prudential Requirements for Remuneration”. The new prudential standard on remuneration (CPS 511) will address recommendations from the Financial Services Royal Commission.

The core elements of the changes to CPS 511 are to:

  • Strengthen governance of remuneration frameworks and outcomes, in particular through an expanded Board role, where the Board needs to be active and have direct oversight.
  • Set overarching remuneration objectives that inform design of all remuneration arrangements and influence remuneration outcomes.
  • Limit the use of financial performance metrics (share price and profit-based).
  • Set minimum deferral periods (up to seven years) for senior executives to provide more 'skin-in-the-game' through better alignment to the time horizon of risk and performance outcomes.

Changes that will help improve the resilience of the financial system and alignment between the interests of financial institutions and those of shareholders, customers and beneficiaries, regulators and the broader community are welcome.

However, the proposal to limit the maximum weighting of financial performance metrics to 50%, and for this to apply to all employees, will have unintended outcomes on APRA-regulated entities.

Financial metrics are more tangible and objective 

We believe the majority of measures for both Short-Term Incentives (STIs) and Long-Term Incentives (LTIs) should be easily identifiable, measurable and relate directly to the company’s performance. Non-financial metrics do not meet these criteria.

Non-financial metrics include, for example, customer outcomes such as loyalty and complaints, reputation and trust, alignment with firm values, employee engagement, teamwork etc.

With these qualitative, non-financial measures, there is difficulty in ultimately devising the correct metrics for each firm. This can create confused incentives, often leading to perverse outcomes.

In contrast, financial metrics which include relative Total Shareholder Returns (TSR), are tangible and objective.

A prime example of a poor application of a non-financial metric was the CBA’s introduction of a ‘people & community’ metric in 2016. Absent of formal intervention by the Board in 2017, application of the ‘people & community’ metric for CEO pay would have resulted in an outcome that was outside the realm of reasonability given the AUSTRAC issues at the time.

By favouring all stakeholders, none benefit

Using non-financial metrics as proscribed by APRA means treating all stakeholders as equivalent. This will inevitability result in a ‘tragedy of the commons’ situation, in which a lack of clear direction leads to a degradation of the business’s ability to focus on long-term value creation for its customers.

This contention is supported by academics. For example, expert in corporate governance and Professor of Finance at NYU Stern School of Business, Aswath Damodaran, predicts that “expanding decision-making to take into account the interests of all stakeholders will create decision paralysis.”

In a world of global competition, a lack of focus at the board and executive level will inevitably lead to poor decisions and poor outcomes for all stakeholders.

We do see merit in using non-financial measures as key performance indicators for specific employee groups, such as front-line staff who interact with customers and suppliers. There are significant differences in staff’s accountability and duty to customers compared to that of the CEO and Board accountability to their shareholders.

Qualitative measures are more easily rorted

Financial metrics such as TSR are not easily manipulated. Improvements in TSR is only achieved as a result of management efforts to deliver benefits to shareholders and stakeholders. However, if a minimum number of intangible measures are mandated by APRA, we expect management will find ways to ensure they are met.

We also have concerns that this could divert management’s focus away from adhering to unbiased accounting practices, reducing financial reporting quality. This could lead to the exact opposite of what APRA is aiming for, and encourage excessive compensation and reduce the independence of Boards.

Should lawmakers decide that components of STI and LTI become increasingly non-financial by nature, we as shareholders will vote against such measures at company Annual General Meetings.

We believe that active ownership, through strong interaction with both Boards and management, will ultimately see better outcomes for all stakeholders. Existing incentive structures, while imperfect, are already highly focused on these outcomes.

 

Will Baylis is a Portfolio Manager with Martin Currie Australia, a Legg Mason affiliate. Legg Mason is a sponsor of Firstlinks. The information provided should not be considered a recommendation to purchase or sell any particular security. Please consider the appropriateness of this information, in light of your own objectives, financial situation or needs before making any decision.

For more articles and papers from Legg Mason, please click here.

 

Additional information (not provided by Martin Currie)

Recruitment consultancy group, Robert Walters' paper, Repair jobs at the banks, makes for additional reading on the subject of wealth management and retail and corporate banking sub-sector wage growth.

 

  •   4 December 2019
  • 3
  •      
  •   
3 Comments
Anthony Asher
December 04, 2019

Damodaran's article makes the reasonable point that you cannot maximise several competing objectives simultaneously. The CEO's he is criticising, however, only committed to the following:
- "Delivering value to our customers.
- Investing in our employees.
- Dealing fairly and ethically with our suppliers.
- Supporting the communities in which we work.
- Generating long-term value for shareholders"
This seems to me to be what he calls "constrained capitalism", and does involve constraints that can be measured and could form part of performance evaluation.
There is however much more to the debate on compensation:
- There is some evidence to show that excessive remuneration is not good for the company, nor its employees.
- There is overwhelming evidence to show that some "objective financial measures" bear no relationship to individual performance so fail to meet even their own stated objectives. Examples are backdated options, links to the overall level of the share market and links to returns on capital that can mean overgearing and turning down profitable projects.

Albert
December 04, 2019

It is not possible to regulate good ethics. waste of time and effort. most people have some morals and know how to balance stakeholders interests. Commonsense approach in our society.
however it is possible and desirable to not pay incentives. If you are being paid millions then there should be no further incentives to take unacceptable risks. we should not tempt CEO's to become living legends by encouraging excessive risk taking behaviour to achieve some bonus.
Without financial incentives, the only motivation left for a CEO is a non monetary one - peer group and community respect for good company stewardship.

George Wilson
December 10, 2019

See "I want to explore the problems that surround the concept of shareholder value and its maximization. I’m aware that expressing skepticism over this topic is a little like criticizing motherhood and apple pie."


https://www.gmo.com/americas/research-library/the-worlds-dumbest-idea/

 

Leave a Comment:

banner

Most viewed in recent weeks

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

Preparing for aged care

Whether for yourself or a family member, it’s never too early to start thinking about aged care. This looks at the best ways to plan ahead, as well as the changes coming to aged care from November 1 this year.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Latest Updates

Investment strategies

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Retirement

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

The ASX is full of broken blue chips

Investing in the ASX 20 or 200 requires vigilance. Blue chips aren’t immune to failure, and the old belief that you can simply hold them forever is outdated. 

Shares

Buying Guzman y Gomez, and not just for the burritos

Adding high-quality compounders at attractive valuations is difficult in an efficient market. However, during the volatile FY25 reporting season, an opportunity arose to increase a position in Mexican fast-food chain GYG.

Investment strategies

Factor investing and how to use ETFs to your advantage

Factor-based ETFs are bridging the gap between active and passive investing, giving investors low-cost access to proven drivers of long-term returns such as quality, value, momentum and dividend yield. 

Strategy

Engineers vs lawyers: the US-China divide that will shape this century

In Breakneck, Dan Wang contrasts China’s “engineering state” with America’s “lawyerly society,” showing how these mindsets drive innovation, dysfunction, and reshape global power amid rising rivalry. 

Retirement

18 rules for ageing well

The rules to age successfully include, 'the unexamined life lasts longer', 'change no more than one-eighth of your life at a time', 'nobody is thinking about you', and 'pursue virtue but don’t sweat it'.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.