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COVID-19 reveals inauthentic governance practices as a new risk to shareholders

21 May 2020 Old Mutual

Old Mutual hopes that the pandemic will open up the broader conversation around unfair remuneration policies that perpetuate income inequality.

The COVID-19 pandemic has revealed another risk to investors, namely: 'governance washing' in the way of inauthentic delivery on sustainable governance guidelines. Responsible asset manager Old Mutual Investment Group has identified this as a real risk that requires focus to avoid reinforcing specific environmental, social and governance (ESG) blind spots in their portfolios ahead of this year's proxy voting season.

This is according to Rob Lewenson, Head of ESG Engagement at Old Mutual, who says that the humanitarian crisis created by the pandemic will be an ethical test for companies genuinely committed to good remuneration policies and those only paying lip service.

The decision of executive teams in South Africa and around the world to take salary cuts in response to COVID-19 is welcomed by Old Mutual. Lewenson says that the willingness of top executives to take some sort of pay cut amid the COVID-19 pandemic is not only touching but is also business appropriate in terms of rebalancing labour force inequality, more so as millions of workers face pay cuts and retrenchment.

"Due to their long-dated contracts, some executives tend to get rewarded in times when shareholders and society are not. This fact, and the disparity in remuneration, is at the forefront of the income inequality conundrum. While these pay cuts alone aren't likely to have a significant impact on companies' bottom line, it should be applauded because it sends a message of solidarity with workers and communities," says Lewenson.

However, he acknowledges that the structure of the long-term incentive plans (LTIPs) could undermine the very intention of the gesture of taking salary cuts and might rather be seen as governance washing. "Like greenwashing — which makes unsubstantiated claims about the environmental benefits of products to make them appear more environmentally friendly to the public, governance washing signals intent on taking a stand against unethical business behaviour while not addressing the underlying company policies that perpetuate the very problem," says Lewenson.

It should be borne in mind that most of these LTIPs were agreed on three or five years before the pandemic hit; what is seen as giving executives undervalued yet sizeable stock options if they hit targets may in fact be per existing contracts.

Excessive executive pay is considered one of the major contributing factors to rising inequality globally. According to a report published by the Economic Policy Institute in 2019, since 1978, CEO compensation in the USA has risen by 940% while the typical worker salary has increased by only 12% during this time.

"Certain CEOs and CFOs are getting more money because of their power over the board to set pay and not because they are increasing productivity or possess specific, high-demand skills. Companies with good remuneration structures, on the other hand, recognise strategic long-term ESG risks and appropriately reward their executives for solving for them," says Lewenson.

"Research has proven that these companies, companies with higher ESG scores, tend to outperform their peers in the long-term and return superior value to shareholders."

It is still early days, but Lewenson expects 'governance washing' to negatively impact the ESG scores of non-compliant companies in the long term. He says that Old Mutual will be monitoring the LTIPs of several companies ahead of the 2020 proxy season, to identify those that may have been artificially adjusted by stock market recovery.

Of the all the resolutions that were voted against in 2019, remuneration policies constituted more than 10% of resolutions voted against. Old Mutual alsoundertook a range of direct engagements with various company management teams on these issues.

"We hope that COVID-19 will be the catalyst of a broader conversation addresses the governance on remuneration policies by giving shareholders a say about pay, encouraging boards to think about long term systemic ESG risks and build this into their rewards structure," concludes Lewenson.

"We hope that the 2020 proxy voting season will once again allow Old Mutual to engage with remuneration board committees of companies and encourage them to think about the long-term ESG objectives around shared value and evidencing that kind of commitment in their reward structure."

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