Do current policies for the remuneration of executive directors of listed property companies deliver value for shareholders? In many cases more transparency and accountability is required, says Phineas Glover
Phineas Glover is researcher at corporate governance consultancy PIRC
Since the Investment Property Databank (IPD) was founded back in 1985, the company has grown into the world's number one provider of independent property investment data. IPD's applicability has now spread as far as being used as a benchmark for assessing executive directors' performance. PIRC increasingly sees IPD indexes used within the remuneration sections of FTSE350 Real Estate Holdings and Development companies.
This is broadly a positive development. At PIRC we believe that a significant proportion of executive directors' remuneration should be structured so as to link rewards to overall strategic corporate objectives and the individual performance of directors. In terms of performance share plans, companies typically use broad metrics such as earnings per share and total shareholder return to measure performance. While this can be applicable in some sectors, we believe that they should be used in combination with evaluations that are specifically relevant to the sector.
As an example, we tend to welcome the introduction by pharmaceutical companies of performance conditions linked to the actual development of medicines; which is of course highly relevant to the performance of the companies. So at first glance, the use of independent IPD data ticks the box for being relevant to the real estate holdings and development sector. However, while we support the nature of the condition, the manner in which it is applied in the various companies is just as crucial as for any other performance condition.
After a short review of the remuneration reports of the FTSE350 Real Estate companies, 34% were found to be using IPD in bonus and/or share incentive schemes. In principle, PIRC supports this apparent increase in use, because it would at least initially suggest a move to sector relevant assessment. Unfortunately, however, we have encountered a number of problems with the manner in which IPD has been applied by the companies.
For one, there is general lack of transparency. Disclosure regarding the operation of the targets is generally insufficient; disclosure regarding the rationale for the chosen IPD index is insufficient and most crucially the companies provide no information concerning past performance relative to the actual IPD indices itself.
When companies use conditions that are not commonly applicable for brokers' forecasts, PIRC believes companies should disclose historical performance and future expectations relative to the actual metric. Moreover, as a minimum, the comparators contained within the chosen index should be disclosed for shareholders so they can make an assessment of their validity as a competitor set. Yet often this does not happen.
For example, the share option scheme of one listed real estate company uses a triple, net asset, value-per-share performance condition relative to the IPD All-Fund Benchmark. The company fails to disclose the rationale for the chosen index, the germane nature of the competitive set contained within the index, or historical performance and future expectations relative to the actual measuring system. Alarm bells start to ring when you see that awards granted since 2001 have all vested in full.
The company indicates that the upper target has been met over each of the three-year performance periods consecutively since 2001 (awards are granted every year); however, shareholders neither know if the targets remain challenging, will continue to be challenging or whether the comparative index is actually appropriate.
What follows is a similar trend among all the companies that use IPD comparative indexing in share schemes. While the level of disclosure varies, our fundamental concerns remain and this general lack of transparency inevitably leads to a lack of accountability. What unfolds is a case of asymmetric information and an imbalance in knowledge between the boardroom and the shareholders. Unlike other performance conditions, which are more easily assessed, directors are not accountable to shareholders when using IPD targets.
There remain other hurdles to be overcome. For example, of all the companies using IPD data perhaps only two use the same index. Many use aspects of different indices, such as the "Capital Growth Component of the (IPD) Index" or the "Investment Property Databank Index for Standard Shop".
Sector relevance is one thing, but slicing and dicing different indices potentially limits the suitability and/or challenge among the comparative group - but then we wouldn't know that much because companies have so far failed to disclose any validation.
The chosen index needs to be carefully structured to ensure a fair basis of comparison; for example, there are potential difficulties in getting a cut of IPD data that contains a selection of properties broadly similar to the particular company's property mix. This is particularly problematic if the company in question is not an IPD participant.
Another concern is that IPD largely relies on the voluntary participation of the relevant companies in filling out the forms and providing all the required aspects to compile the indexes. Presumably there is the potential, if some of the best performers in a competitive set fail to return the required information, that the index will be weighted toward average performers and further that the standard deviation will be altered so that slight outperformance of the average will lead to an artificially magnified percentage outperformance.
The ultimate risk here is that, unless a standardised approach is formalised for the application of IPD data in remuneration, there is the possibility that directors are being handsomely rewarded for average performance and shareholders may be receiving poor value.
The fact remains that there is tremendous potential in the use of IPD data when formulating performance conditions for directors. One example that stood out was of a listed property company that used IPD data as an underpin. If performance over the preceding three years didn't meet the IPD target requirement, then no actual shares would be granted to enter the proceeding performance cycle.
There is no doubt that IPD indices offer a powerful sector relevant tool to assess executive performance. However, the remuneration committees now need to apply them in a transparent and accountable fashion.