Saudi’s Tadawul opening: How will executive pay be impacted?

The opening up of the Saudi stock market to qualified foreign investors presents some potentially interesting challenges to the boards of companies listed on Tadawul.

New overseas investors – qualified foreign investors – are likely to be comprised principally fund managers and pension funds, (institutional investors). The shareholder base is therefore likely to change from one that is currently dominated by individual retail investors to one where large international funds are more common and more active in engaging with company boards.

Although the kingdom has relatively well developed standards on corporate governance and the regulatory and reporting frameworks, international standards and regulations (primarily US, UK and EU), often go much further. International investors, coming from an environment of greater disclosure and transparency may well approach investing in the kingdom with the same mindset. They are likely to want to be assured that those companies seeking injections of capital are well governed, disclose appropriate information and explanation and engage with their major shareholders.

In respect of executive compensation, investors will want boards to be able to demonstrate that the interests of executive management are aligned to the interests of shareholders. After all, why would an investor buy shares in a company if executive management do not have a similar exposure to the risks and benefits of changes to the company share price?

In this context can we expect international institutional investors to apply international standards and expectations on corporate governance, shareholder engagement and disclosure issues in the kingdom? Here’s the potential impact there may be on the issue of executive pay.

Composition of the Nominations and Remuneration Committee – in many major markets all committee members are typically wholly independent and non-executive. CMA rules specify only that a “sufficient number” of non-executive directors should be appointed to board committees.

Will investors expect to see all companies staff their committees with independent and non-executive directors? Are there sufficient numbers of suitably experienced and qualified individuals in the kingdom or the region more broadly to sit on these and other key committees?

Aligning shareholder and executive interests – as noted above, most institutional investors expect to see some clearly defined relationship between their interests and those of executive management. Typically this is most commonly addressed through the provision of long-term incentives where, subject to certain vesting conditions, executives are rewarded not just through base salary, allowances and cash bonus but also in company shares delivered through the long-term incentive.

Moreover, increasingly common in other markets are share ownership guidelines. Executives are required to build up a specified value in company shares, (often expressed as a percentage of base salary or fixed pay), which must be retained whilst that individual remains an employee of the company.

Although a number of Tadawul listed companies operate long-term incentives, it is not yet majority practice. Can we expect to see investors urging companies to implement such arrangements in the future? What rationale could be presented to investors if such arrangements are not in place? 

Delivering pay for performance – issues around how much to pay, and for what levels of performance and over what period of time, have attracted media headlines around the world, particularly in respect of perceived high levels of total compensation.

Although the issue is complex and often difficult, investors will nevertheless want to be assured that the structure and levels of executive pay reflect both annual and longer-term performance. Equally important will be the fact that companies will need to be able to demonstrate how total pay (fixed pay, annual bonus and long-term incentives), changes or flexes with company performance and that outcomes can be judged as fair and reasonable to all stakeholders. International investors may well therefore expect more voluntary reporting and disclosure of executive pay in the annual report and accounts or through private correspondence in order to allow them to assess how well pay for performance is working in reality.

Shareholders may well ask for details on the selection and weighting of KPIs used in executive incentives as well as how threshold, target and maximum opportunities are linked to the KPIs and the rationale for it.

Will boards need to play a more active or challenging role in agreeing KPIs and performance goals with executive management? What are the implications for companies seeking to translate their business goals and strategies into executive pay plans? What are appropriate levels of pay out for differing levels of performance?  

Greater shareholder engagement – many major markets operate some form of “say on pay” -whether on an advisory or binding basis. This allows investors to express their views on the level and structure of executive pay on a regular and recurring basis. In addition to say on pay, investors may also expect to be consulted independently prior to any vote. This allows shareholders to provide feedback on any proposals and allows companies to explain any rationale or reasons behind the proposals which they may not wish to disclose publicly for commercial reasons.

Companies may well find that international investors contact them directly to learn more about how corporate governance operates in practice in their companies and may well express a view that they would like to have some input to how executive pay is structured and delivered going forward. How welcome would such interventions be and will boards and Nominations and Remuneration Committees be adequately prepared?

More disclosure on pay – although the Capital Markets Authority sets out some requirements on disclosing the pay of executive management, they are summary and aggregated. Other major markets require companies to set out its remuneration strategy, remuneration details on individual and named executives, as well as details on the design and operation of annual and longer-term incentives, including the KPIs used to assess performance.

Nominations and Remuneration Committees will need to be able to demonstrate that executive pay has been designed thoughtfully and that the process and reasons for arriving at decisions are sound, well governed and based on facts and data. How comfortable will companies be in disclosing more information than has been the case in the past? How much should be disclosed and in what format? How will commercial confidentiality considerations be addressed?

Recovery of executive pay awards – in many other markets regulatory and/or investor expectations are that Nominations and Remuneration Committees have the discretion and authority to seek recovery of pay (whether already paid or about to be paid), in certain circumstances. For example, previous bonus awards were made based on financial information that was later found to be incorrect or even fraudulent and which would have led the Committee to come to a different original decision if these facts were known at that time. Indeed, SAMA’s rules for the banking sector in the kingdom require such policies to be put in place as one method to help institutions manage pay and risk.

There are two tools generally available to committees. The first, malus, is where an award that is yet to pay out can be reduced or even cancelled before it is made over to an individual. For example, a long-term incentive award may be due to vest but a committee determines that because of inappropriate behavior or bad practices, only a portion of what should vest will in fact be made over to an executive.

The second, claw back is where the committee seeks to recover awards that have already been paid (and spent?), by an executive.

Should companies seek to implement such policies in line with international practices as well as those applied by SAMA? In what circumstances would these policies apply and how would a decision be made in respect of how much might be deducted from what might have been paid? Should malus or claw back be applied to individuals, teams, divisions or even the whole company? What are the implications for re-drafting executive contracts if malus and claw back policies are implemented?

While the opening up of Tadawul to qualified foreign investors will bring welcome liquidity and capital into the region, there may well be implications on how committees engage with shareholders in order to explain how their executive reward strategy supports business goals as well as disclosing more information around how the committee has arrived at the decisions being made.    

Andrew Marshall is head of Executive Compensation for the region at Willis Towers Watson