In a recent discussion with a prospective client, we were informed that the particular board wanted to issue performance rights to its NED’s in order to ‘retain’ and ‘motivate’ them failing which, they would resign. We advised against such actions and were informed that such approach represented ‘market practice’ and in any event, their company was too small for anyone to take any notice of them.
In a perfect world all NED’s would be appropriately paid, and exploration companies would be able to attract directors with the right skills and experience to ensure that their board can function effectively for the benefit of all shareholders.
In the Trenches
BDO’s quarterly latest report on listed explorers found that exploration companies continue to be focused on preserving their cash. In contrast to previous BDO surveys, the March 2017 quarter revealed a decrease in median exploration expenditure to $91,000.
We attribute this move by explorers to further develop their existing exploration assets, rather than explore, as well as company’s tendencies to preserve cash. In addition, 37% of companies only had sufficient cash to cover their administration costs for only one or two quarters. Total administration expenditure which includes payments to directors, decreased in line with exploration expenditure from $213 million in the December quarter to $175 million in the March 2017 quarter.
Unfortunately, financial constraints and the absence of the required skills increase the vulnerability of small-cap companies to bad governance standards, and in many instances, the distinction between management and board becomes blurred. This is not only a concern to shareholders but it also creates anxiety for investors when looking at the company’s remuneration practices.
What does this mean?
Increased regulation, depleting cash resources and volatile markets means that explorers need professional and seasoned non-executive directors on their boards however, many explorers lack the cash to attract and retain them.
Is There an ‘Exploration Solution’?
ASX governance principles emphasise the role that remuneration plays in the oversight function within a listed company. The principles state that companies “need to ensure that the incentives for non-executive directors do not conflict with their obligation to bring an independent judgement to matters before the board”.
Confused! Does this mean we can give equity to our NED’s or not?
You can, and there is regulatory and institutional support for it.
The Australian Institute of Company Directors encourages the purchase of shares at market price by directors through the sacrifice of a portion of their fees under a company scheme. AICD also encourages schemes that ensure directors hold these shares so long as they are serving on the board.
The ASX Corporate Governance Council states that “It is generally acceptable for non-executive directors to receive securities as part of their remuneration to align their interests with the interests of security holders. However, non-executive directors generally should not receive options with performance hurdles attached or performance rights as part of their remuneration as it may lead to bias in their decision making and compromise their objectivity”.
The Australian Council of Superannuation Investors believes that directors should have sufficient skin in the game to provide alignment between both director and investor interests-although the correct level of holding varies in the views of investors. An emerging rule of thumb for NED’s is that they should have invested an amount equivalent to at least one year’s director fees, and some companies are now implementing minimum director holding measures”. ACSI Annual Survey of S&P/ASX 200 Board Composition and NED Remuneration: November 2016.
Glass Lewis, the independent provider of global governance services, confirms that to protect the independence of NED’s, NED options should vest immediately and not be subject to performance hurdles. NED options should also be appropriately valued and the value of options granted and any cash received should be in line with NED remuneration levels for market index peers
Blackrock, the world largest investment management company, says that smaller companies in development/exploration phase such as mining companies, which typically have high cash burn rates and little or no income from operations, Blackrock will support the grant of options or share rights to NED’s where the options are issued in lieu of cash fees (as a cash saving measure), there are no performance conditions, full vesting occurs within 12 months of grant date.
The Good News
The good news is that there is a solution to the dilemma facing exploration companies who have to meet the same corporate governance benchmarks as the largest listed companies whilst trying to direct their limited cash resources into value increasing exploration.
The ‘Silver Bullet’ – the BDO Non-Executive Director Pay Approach
BDO have developed an approach that determines an annual fixed fee taking into a number of factors which include:
The individual’s reputation, track record, experience, expertise, industry understanding and network reach
The role which is to be performed by the individual i.e. main board chairperson, committee chairperson, committee member etc.
The company’s dynamics i.e. size, complexity, competitors, ‘footprint’ etc.
The market which is represented by a valid and reliable peer group.
As part of our process, we are able to determine what is ‘reasonable time’ for a NED to perform their duties based on the size and stage of the company’s development, Once the aforementioned factors have been considered, we apply our BDO methodology, in addition to input from the company’s board, to determine a total fixed annual fee.
The total fee package represents two components being the annual fixed board fee and an equity component (up to 33% of the total fee package). This equity component has no performance conditions and does not increase the NED fee above that of the market. It aligns NED fees with the market based on the time, responsibilities and calibre of the incumbent.
Contrary to belief, explorers do have the resources to attract, retain and motivate the right calibre of individual for their boards in a manner that preserves the NED’s independence, and ensures that their interests are aligned with their shareholders.