Pay X-Ray
Pay X-Ray |
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Spotlight on Incentives
Given our long history of investor-led engagement with companies on the subject of pay, we have identified certain compensation scheme practices – such as earnings adjustments – that we believe to be red flags.
We are wary of incentive schemes that rely too heavily on earnings per share (EPS) as an evaluation metric. If management are getting paid on EPS, it can be tempting to manipulate those earnings using short-term tactics – such as increasing debt or making unwise acquisitions – at the expense of shareholders’ long-term returns.
We are equally sceptical about compensation based on “adjusted” earnings, the adjustment meaning that things such as write-offs, costs associated with environmental blunders, or the decision to cover expenses by issuing shares aren’t taken into account when pay is being decided. No wonder we tend to refer to them as ‘earnings before the bad stuff.’
There are other compensation scheme tactics we prefer to avoid. We try to steer clear of companies that award high pay for ordinary, or poor, performance. Time served or the ability to show up every day is not a good enough reason to award shares, in our opinion. Moving performance goal posts to suit current circumstances is also frowned upon. For example, a global company with exposure to multiple currencies choosing to reward management when currency movements boost earnings but ignoring or discounting any negative effects of currency moves.
ALIGNMENT WITH SHAREHOLDER INTERESTS
What we prefer to see in the companies we invest in are clear, ambitious goals that are aligned with shareholder interests. We like to see management compensated for achieving return on capital targets, and regularly engage to encourage this. Our engagement has resulted in such practices being adopted in a number of the companies that we invest in.
We support minimum levels of management share ownership and actively engage to encourage such ownership requirements stay in place for a period after executives retire. Having such an arrangement in place prevents any temptation to inflate results in an unsustainable manner, ensuring a high payout for the executive on exit but damaging long-term shareholder returns.
THE PAY X-RAY
Every company pay scheme is different, so we created the pay x-ray to provide a more level playing field. Using a proprietary scoring mechanism we can compare the pay plans of all of the companies we invest in and make decisions on those we will vote in support of, and those we won’t. In addition, the pay x-ray creates discussion within the investment team, as well as highlighting specific issues for engagement. Our Engage report, published twice yearly, provides examples of this in action.
In a deeply imperfect world, we do not want our search for ‘perfect’ to get in the way of the reasonable, especially if our pay x-ray shows the reasonable is improving year-on-year.
RISK CONSIDERATIONS
There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market value of securities owned by the portfolio will decline. Accordingly, you can lose money investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy's assets were invested in a wider variety of companies. In general, equity securities' values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Option writing strategy. Writing call options involves the risk that the Portfolio may be required to sell the underlying security or instrument (or settle in cash an amount of equal value) at a disadvantageous price or below the market price of such underlying security or instrument, at the time the option is exercised. As the writer of a call option, the Portfolio forgoes, during the option's life, the opportunity to profit from increases in the market value of the underlying security or instrument covering the option above the sum of the premium and the exercise price, but retains the risk of loss should the price of the underlying security or instrument decline. Additionally, the Portfolio's call option writing strategy may not fully protect it against declines in the value of the market. There are special risks associated with uncovered option writing which expose the Portfolio to potentially significant loss.
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