In a stunning rebuke to Telstra (ASX: TLS), nearly 62% of shareholders voted against the company’s 2018 Remuneration Report at yesterday’s AGM.
This is despite CEO Andy Penn’s total compensation falling by 28%, from $5.2m to $3.7m, in 2018 due to a reduction in his short-term incentive compensation and him receiving zero long-term incentive compensation.
Overall, his total compensation has now fallen by around half over the past two years.
But even this wasn’t good enough for many investors and proxy advisors, who questioned why any incentive compensation was paid at all and made their displeasure known in the vote against the Remuneration Report.
Share price falls, dividend cuts the real reason
I don’t agree with this logic and neither did Telstra Chairman John Mullen in his speech to the Telstra AGM.
While agreeing that executive compensation in general is too high, Mullen also noted that “some of the same shareholders who voted for our variable remuneration scheme last year now voted against it, even though the scheme has not changed”.
And that “proxy advisors who were OK with our combined scheme last year now say that they are not happy with it”.
Not mincing words, Mullen stated the obvious: that the remuneration report was voted down because Telstra’s share price has fallen.
And I can see why shareholders are displeased.
While Telstra’s share price is “only” down 11% over the past year, it has fallen 18% from the high of $3.71 reached in January this year and is now around 54% beneath the $6.59 it reached in February 2015.
Even worse, in 2018 Telstra cut its dividend from 31 cents to 22 cents per share, a reduction of 29%.
Does anyone reading this think Telstra would have received a first strike if its share price had risen 10% – and its dividend been increased – over the past year instead?
But why bother?
Of course, as Mullen also noted, if incentive or variable compensation is primarily seen as a reward for a rising share price, why bother with a complex, time-consuming and expensive remuneration scheme at all?
Why not remove all the conditions, variables, exclusions, etc and just pay senior executives half in cash and half in shares?
No simple solution
Unfortunately, this raises its own problems.
Incentivising senior executives to simply get their company’s share price higher just encourages management to run the business for the short term rather than the long term.
It will just encourage management to cut costs wherever they can, even essential costs that are necessary for the day-to-day running of the business, while also encouraging them not to invest for the future. Whether it is investing in a new product, opening a new store or perhaps expanding into a new market, that these investments will likely take a number of years to become profitable will mean management will try to avoid making them.
I think the vast majority of investors would disagree with any business being run this way.
So as you can see, there isn’t a simple solution to this issue.
Even so, if I was forced to choose just one metric to incentivise senior management, I would choose return on funds employed. Although even this isn’t perfect – for example, as debt is generally cheaper than equity it could encourage excessive leverage – at least it forces management to consider whether it is generating adequate returns with the capital it is managing.
This can only benefit shareholders over the medium to long term which, after all, is the ultimate goal of all forms of incentive compensation.