Annet Aris: ‘Time for a Hard Reset of the Remuneration System’

Annet Aris: ‘Time for a Hard Reset of the Remuneration System’
The focus on compliance and box ticking in the remuneration file seems to have become an end in itself, says INSEAD professor and top Supervisory board member Annet Aris. She advocates stepping back to build a new paradigm for an effective and transparent remuneration system from the bottom up and together with all governance players. ‘Shareholders and proxy advisors have rules that they strictly enforce, while these often turn out not to have the effect they think. Academic research on compensation measures can shed new light on their effectiveness.’

The season of annual reports and AGMs (general meetings of shareholders) is in full swing when we speak to Annet Aris in the bright and tastefully decorated living room of her home in The Hague. Her already busy schedule these first months of the year also includes the annual meetings of the companies she oversees. Exactly one week after the interview is the shareholder meeting of temporary employment company Randstad, where she will lead as chairman of the Remuneration Committee. April 26 follows the shareholder meeting of chip machine manufacturer ASML, which she will attend as vice chairman of the Supervisory Board and remuneration committee member. Aris also sits on the Aufsichtsrat of German forklift manufacturer Jungheinrich where she introduced a new remuneration policy – the day after our conversation she travels to Hamburg - and until recently she was a Supervisory Board member of Rabobank.

Tighter reins
Director compensation is a topic that causes a considerable stir among shareholders and in society. For that reason, the Remuneration Committee is even seen by some as the most difficult committee within the Supervisory Board, partly because of the increasing reputational risk. However, Aris says she does not lose sleep over it. ‘I just do my homework and my best. You think carefully about decisions, explain them as well as possible, and that is all you can do. I do notice that the external environment tightens the reins every year. If you miss one tick on the checklists, the remuneration proposal or policy immediately receives a negative vote from shareholders or proxy advisors. So, you must be even more careful and alert.’ Nevertheless, the Remuneration Committee must trust its own compass, she believes. ‘Occasionally you must have the courage to choose a reward that you just find appropriate, ─ even though you know it will be criticized. For example, if circumstances force you to say goodbye to a director who has always performed well. No golden handshake, but a reasonable severance package: that is good employment practice. And if the world subsequently falls on you, so be it.’

Back to basics
According to Aris, the remuneration debate is characterized by a downward compliance spiral of increasingly detailed and complex regulations and reporting requirements that miss the mark. She advocates a return to the basics: fair remuneration that encourages executives to create long-term value in a broad sense. It is time for a hard reset of the remuneration system.’ She is eager to contribute to that, as academic director of INSEAD’s Corporate Governance Centre, a role she recently assumed in addition to her position as professor of strategy at the renowned business school in Fontainebleau, France. Aris aims to build a bridge between the scientific insights on remuneration and the players in the practice of the remuneration debate: shareholders, works councils, proxy advisors and remuneration consultancies. So, plenty of food for thought for the interview with Roel van der Weele, leader of Deloitte’s executive compensation consulting practice, on the changing roles of the remuneration committee and the contours of a future-proof remuneration policy.

What role does the chairman of the remuneration committee play? 
‘You are like a spider in a web. The remuneration committee must be diverse, with both people who approach remuneration from an Anglo-Saxon angle and from a more social, Rhineland perspective. As chairman, you must make sure that all these perspectives are included in the discussion and keep the balance of interests on the right track. In addition, you talk to all stakeholders: the board, the works council, and the shareholders. You also speak at the AGM. So as chairman, you are constantly engaged in internal and external coordination, especially when there is a change in remuneration policy and difficult remuneration issues. She laughs out loud, ‘I always say: you did well when everyone is a little angry.’

In the Netherlands, shareholders have the right of consent on remuneration policy and the right of advice on the final pay awarded. Should the latter vote become binding, as in some other countries?
‘That would not have a positive effect, I think. As remuneration committee you have to react to negative opinion from shareholders anyway, even if it is non-binding. If your remuneration report is voted down: of course, you think about it. But the role of the supervisory board is to weigh up all the interests. On that basis you take a decision or support a remuneration policy that you think is right, even if some shareholders are angry about it. You then have to have a thorough dialogue about it. In my opinion this is a better solution than further bureaucratizing the process.’

Investor organization Eumedion believes that companies too often fail to follow the advice of shareholders. For example, Philips’ top management received a bonus last year anyway, despite 80 percent of shareholders voting against it.
‘The example of Philips has set off alarm bells among shareholders, but these are incidents, not structural developments. There often is a reason behind it, such as contractual obligations that a company cannot get out of. You should not implement radical policy to quell those few incidents, because the indirect effects can be worse than the problem you want to solve.
On the other hand, Supervisory Board members should be alert to groupthink in their relationship with the board.
According to agency theory, the shareholders as principals have delegated the power to make certain decisions to the Supervisory Board as their agent.  Thus, the Supervisory Board members should include both the shareholders’ and the board’s views on remuneration policy in their deliberations. However, there is always the risk that the shirt - the board - is closer than the pants, the shareholder. So, I understand that the pants try to exert counter pressure, that critical attitude is also part of the role of shareholders. I do think that they should however not just scrutinize whether all the checkmarks have been ticked, but really delve into the remuneration philosophy to understand the trade-offs made.’

Eumedion advocates better dialogue with shareholders but does not rule out voting against the (re)appointment of Supervisory Board members and Remuneration Committee members in the long run. Would that influence Remuneration Committee decisions?
‘I should hope not, as a Supervisory Board member you must remain independent and not bend with only one stakeholder. The philosophy behind that dissenting vote is that as chairman of the Remuneration Committee you have more arguments to say to the board, ‘Guys, I cannot do this because then I will be voted out.’ So, it is supposed to act as a kind of support. I think that is a bit immature and weak. If you are, to put it in German, a gestandene Supervisory Board member, you should be able to look directors straight in the eye and say: We are not going to do this adjustment to the remuneration policy, or: We stand by the increases we decided on.
If shareholders do indeed start looking critically at reappointment of Supervisory Board members, they could return some room for the exercise of discretion by the Supervisory Board. That space has disappeared completely, actually that indicates a lack of trust in Supervisory Boards.’

Shareholders are often guided in their voting decisions by proxy advisors, such as ISS and Glass Lewis. How do you view their role?
‘They are necessary players because large shareholders cannot look at all their individual investments themselves because of the size of their portfolios. Proxy advisors also have a clear corporate governance framework, so you know where you stand as a board and Supervisory Board. What does beg the question is: who controls the proxy advisors? ISS, for example, is owned by Deutsche Börse and has paying members, but do they challenge the way they work and the quality of the advice given? Is there a thorough evaluation process? It would be good to scrutinize the way they work once every two or three years. A party that sets the rules of good governance for others should also regularly look itself in the mirror and have its own governance in order.’

The Remuneration Committee must consider not only the shareholders, but an increasingly broad range of stakeholders. How do you enter dialogue with them?  
‘First of all, you have to be careful not to sit in the executives’ chair. But it is good to have a direct dialogue on remuneration policy with the shareholders and the works council. Maintaining a dialogue with society is more difficult, which is something Remuneration Committees struggle with. Because who is this society and if you do a survey, what does it say? As a Supervisory Board, you can include KPIs in your dashboard, such as: how satisfied are customers and what is the reputation of the company? That way you can monitor the balance. Because a company can achieve an impressive financial performance, but if the customers are unhappy, something is not going right.’

The Remuneration Committee’s own role is also broadening to include ESG topics such as culture, diversity, social equity, and sustainability. What does that mean for the committee structure in the Supervisory Board?
‘Rabobank does not have a Remuneration Committee, but an HR committee, of which the remuneration policy is a part. There we always talked very broadly about culture change, engagement scores, or the HR organization. Those were incredibly fun, interesting meetings. It is good to do a deep dive into these kinds of topics, just as the Audit Committee does into the financial numbers. Some Nomination Committees also have a strong HR component, in that they look beyond just the appointments on the Supervisory Board and Executive Board but also focus on succession planning and flow through the pipeline. Then it is just a small step to the whole HR building. Well, does that belong to the Nomination Committee or the Remuneration Committee? Merging probably makes the committee too cumbersome. Incidentally, it is sometimes argued that HR should be on the agenda of the entire Supervisory Board. That is true, but that agenda is often already incredibly full. At Rabobank I found it very useful to have sufficient time in a smaller committee to discuss these kinds of subjects.’

In your view, what does a future-proof remuneration policy look like?
‘We see ourselves facing several dilemmas. First: what is the relationship between variable and fixed remuneration? In addition: what percentage should or should not be linked to share prices? Further: what is the weight of financial and non-financial criteria and how do you define good KPIs for ESG? Are output KPIs sufficient, for example: how satisfied are clients and employees? Or should we move toward input KPIs, for example: how is the digital transformation going, are ICT projects being realized on time? And finally: what is a fair wage gap between the board and the rest of the company, how do you determine the right pay ratio in a company or sector? For all these remuneration issues, shareholders and proxy advisors apply rules that they strictly enforce, while these often turn out not to have the intended consequences. Academic research on compensation measures can shed new light on their effectiveness. The result of one such study, for example, indicated: the larger the percentage of share payment, the stronger the short-term focus, while shareholders also benefit from long-term value creation. So, we need to take a step back: away from the details in which we have become bogged down and with which we make each other’s lives so difficult, and together with all the players look again at the essence of effective and transparent remuneration policy.’

How can we achieve this hard reset of the existing remuneration system in concrete terms?

‘With INSEAD’s Corporate Governance Centre, we want to start collecting academic research for all the dilemmas mentioned: which remuneration scores work, and which do not? We then want to initiate a discussion with all parties in the field of remuneration as a neutral platform. A first conference is planned in May in which we will bring together top academics and top Supervisory Board members. We also want to involve major investors, proxy advisors and remuneration consultants in our events. That way you can combine brainpower, find the right balance between theory and practice, and together take the solution of those dilemmas a step further. Then you talk about things like: which remuneration measures are most effective according to scientific insights? Does that differ by culture and what does that mean for international companies? What are the trade-offs: if we strive for a fair pay ratio, do we take for granted that we can no longer attract certain people and what does that mean for the company’s performance? And: is there a willingness among shareholders to experiment with remuneration policies based on academic research, rather than current best practice and checklists? By having a dialogue about these kinds of tough questions, we can work together to create a new paradigm in remuneration.’

A kind of great reset at a ‘World Remuneration Forum’?
She laughs. ‘Something like that yes, only to me remuneration is such a terrible word. Replace it with the simpler pay? No, I am looking for a new term that expresses that reward is a tool for steering and monitoring long-term value creation and realizing positive impact. We at INSEAD did come up with a slogan for ourselves as a Corporate Governance Center: we want to be the G of ESG. So far, when it comes to ESG, we have been talking mostly about the E and the S and less about the G of governance. That G is often associated only with rules, while good governance goes much further and is indispensable for the effective and transparent functioning of ecosystems. Hence my appeal for us to take that step back together and take a critical look at effective remuneration measures, at a good division of roles and mutual trust, at real transparency instead of a remuneration paragraph in the annual report of 20 pages that nobody reads or understands, and at the necessary checks and balances for all parties. This is desperately needed if we want to future-proof our business operations and remuneration policy.’

This interview was published in Management Scope 04 2023.

This article was last changed on 11-04-2023