With annual general meetings now taking place virtually, shareholders, employees and suppliers have had to adjust to lockdowns. While some of the immediate impacts will be phased out with the opening of the economy, stewardship priorities and corporate values may change forever.
Far from derailing the environmental, social and governance (ESG) agenda, the fallout from the COVID-19 pandemic has seen a marked divergence between companies and executives responding positively and responsibly and others that have fallen well short of those standards. Even as economies begin to recover, these differences are unlikely to be forgotten.
Chief executives and remuneration committees tabling irresponsible pay packages can expect a withdrawal of support, even up to re-election of the chairman in extreme cases.
In the second of a two-part Q&A, Mirza Baig, global head of governance at Aviva Investors, discusses how COVID-19 has put the spotlight squarely on corporate behaviour, with fairness and transparency to the fore. And, with the killing of George Floyd triggering anti-racism protests across the globe, he also discusses why investors' engagement on diversity issues needs to be expanded to "fully reflect the spectrum of marginalised communities".
Has COVID-19 changed the focus of your engagement with companies during AGM season?
Euan Munro, our chief executive, set out our stewardship priorities in February in his annual letter to the chairmen of the world’s largest companies. In addition to climate change, it emphasised how companies must better articulate their long-term investment case and move away from excessive focus on short-term performance. We also outlined our expectations around effective leadership and diversity at the board level. Boards must seek to reflect modern society; mirroring its customers, employees and suppliers.
Discussions with companies became dominated by near-term survival issues in the early stages of the COVID-19 crisis
For obvious reasons, our discussions with companies became dominated by near-term survival issues in the early stages of the COVID-19 crisis. As an investor, we recognised companies needed flexibility around certain governance standards and protocols; for example, postponing AGMs or raising capital in a manner that would not have been acceptable in normal circumstances. Regulators were similarly adopting a more flexible approach when it came to compliance with listing rules and company law. There was no point talking about long-term systemic issues if a company could not survive beyond the summer.
But our conversations quickly turned to how companies should position themselves for the recovery. Our focus was not on near-term earnings, but preserving capital and protecting the strength of the franchise. In some cases, dividends had to be cut in order to meet that goal. We also advised companies to avoid rash decisions about redundancies or cutting investment. Consistent with our future-focused investment and ESG approach, the potential growth opportunities in 2021 and beyond was more important to us than short-term profits. It was essential companies did not inadvertently undermine their long-term investment case by fundamentally weakening their key assets, such as the innovation and dynamism of their employee base.
Will COVID-19 accelerate the move to a multi-stakeholder corporate model?
There has to be a greater appreciation of the importance of employees and the supplier ecosystem. We also need to go through a period of reflection about how to properly recognise the value generated at different levels of a company. Senior leaders are important, but not the exclusive factor in the delivery of an organisation’s success. This will inevitably re-open conversations about the appropriate pay ratio between senior executives and average employees.
What does “doing the right thing” mean in the context of COVID-19?
It means any pain should start at the top. We have been communicating that any pay cuts should affect senior management first; whether that means a cancellation or reduction of bonuses, lower future share awards, or even a temporary suspension of salaries. Those measures should come before any scrutiny or decisions about longer-term, wide-scale, redundancies or restructuring.
We do not think companies can continue to bleed cash just to maintain an unrealistic or inflated employee base
The same applies to investors. There is a greater acceptance dividend cuts are on the table before heavy corporate restructuring. However, we do not think companies can continue to bleed cash just to maintain an unrealistic or inflated employee base, especially in industries like airlines where structural change is underway. The likes of BA, Virgin and EasyJet are talking about deep cuts of potentially up to a third of their workforce.
In circumstances like these, responsibility means making cuts in an appropriate manner, not necessarily avoiding them altogether. It could mean postponing cuts until the economy is open, when employees stand a better chance of finding other jobs or ensuring equal treatment of employees from different backgrounds or levels of seniority. The discussions should be open, transparent and fair.
There are concerns in the airline sector that engagement is not up scratch with some of the unions. We would not expect full agreement on terms early in the process, but it does serve as a red flag on how the negotiations may pan out. Any company going through a transition of this magnitude needs an understanding with its employees to avoid future unrest or industrial action.
Should jobs at the lower end of the pay scale be remunerated to the same extent as higher managerial or executive roles?
FTSE 100 bosses on average are paid more than 110 times their average workers, which looks increasingly indefensible. Although the right number will vary by company and sector, the overall number has to fall. In future, we would not expect CEOs to get bumper pay rises just because they are proportionately in line with average workforce increase. A rise of five per cent on a £20,000 salary is very different compared to the absolute increase in pay that would be enjoyed by the CEO. This is a simple place to start to begin tackling the disparities.
What is your message to companies about 2021 bonuses and pay awards in general?
Prudence and restraint are the watch words. There will be a lot of focus on bonuses and discretion must be applied. It would be concerning if a company is unable to provide guidance to the market but maintain internal opaque measures of success that trigger significant pay-outs. That would cast doubts on the framework being used to evaluate and reward management.
There is an elephant in the room: the volume of shares being granted as part of annual incentive programmes. Several executives were granted future vesting share awards at the height of market volatility and at low points in the market.
Executives are potentially in line for bumper windfalls – far exceeding the value of any salary and bonuses forgone
To maintain the same value of awards relative to salary, many executives received a substantive increase in the number of shares compared to previous years. With the FTSE 100 and other indices around the world up more than 25 per cent from year lows, executives are potentially in line for bumper windfalls – far exceeding the value of any salary and bonuses forgone. This is a particular issue in the US. As an example, the CEO of a sporting goods business gave up a $1 million salary, but in return received a whopping share award that has delivered $20 million in potential gains in just three months. Factor in the three- to five-year period of share price recovery after which the awards will ultimately vest, and the problem is compounded. We expect remuneration committees to be cognisant of this and will use our voice and vote when they are not.
We have voted against over 40 per cent of pay packages over the last five years and will continue to withhold support from proposals that deliver excessive and unjustified pay. Increasingly, we vote against pay proposals and the individuals that make them, typically members of the remuneration committee. Where we have substantial concerns, we will escalate this to the wider board and even withdraw support for the re-election of the chairman.
Will companies slash office space over the longer term? How would more remote working impact governance and culture?
This is inevitable to some degree. A lot of companies, especially in financial services, are already reducing office space. Financial services companies tend to have offices in the most expensive parts of major cities so there are significant cost savings to be had. Nevertheless, there are governance risks to consider. There will certainly be more cyber security and data risk. Through the crisis, companies have tended to focus more on the availability of their systems rather than the security. That is understandable, but an increase in breaches is to be expected.
As businesses grow and reopen, new hires will come in and it will be a real challenge to integrate them into virtual companies
The impact on culture is another important issue. People have been surprised at how seamless the transition to working from home has been. However, this favours long-term employees. As businesses grow and reopen, new hires will come in and it will be a real challenge to integrate them into virtual companies, particularly when it comes to career progression and promotions that are often underpinned by relationships with peers and senior management.
Digital working may also dilute culture and corporate purpose, and companies will have to adapt. Culture binds people together that are associated with an organisation, its vision and objectives. That sense of collective culture has traditionally required some level of physical interaction for the communal spirit to be built and maintained. This is not impossible in the cyber world, but a lot harder. The way that companies develop and nurture their culture will have to adapt and evolve, utilising the technology that has now become the centre of working life.
What about employee wellness if companies incorporate aspects of lockdown over the longer term?
The concern is that there is a spectrum of working environments at home – be that based on facilities or space available or requirements to juggle childcare responsibilities. Companies need to ensure decisions on long-term working patterns are not overly geared towards their more economically and socially advantaged employees. Companies need to be inclusive and cater for the personal circumstances of all employees, otherwise we are in danger of exacerbating existing wealth and gender inequalities.
Beyond COVID-19, the world’s attention has been focused in the past couple of weeks on racism in the wake of the George Floyd killing. It has also prompted a response from many company leaders. Will this change our own engagement on racism and other issues of social injustice?
The first thing is to recognise we have a problem and a collective responsibility to work towards a solution. The average wealth of a white family in America is 10 times that of the average black family – this can’t continue. It must also be acknowledged that the US does not have a monopoly on inequality. The problem is systemic and global.
We need to ensure the diversity agenda is expanded to fully reflect the spectrum of marginalised communities
For over a decade, we have been calling for greater levels of diversity and inclusion within corporate practices. However, this has tended to be interpreted through the narrow lens of gender. We need to ensure the diversity agenda is expanded to fully reflect the spectrum of marginalised communities, including colour, race, disability and class.
It is not good enough companies satisfy themselves with policies that simply prohibit discrimination – this only serves to perpetuate the status quo. If we are going to make a dent in tackling a legacy of institutionalised racism and inequality, it will necessitate proactive action to address the imbalance. Companies can make a difference. We have to make sure our company engagement begins examining every touch point that businesses have with suppliers, partners, employees and customers, and explore ways to provide better opportunities to disadvantaged communities.
We don’t have all the answers, none of us do, but we are committed to being part of the movement for change.