Relatively speaking, BHP heavyweights deserve their bonus
The shares were valued at $43.6 million on Friday, and they are the end-product of a five-year benchmarking process that measured the value BHP created between the fourth quarter of 2008 and the fourth quarter of this year. BHP's Australian share price averaged $44.04 in the fourth quarter of 2008. It averaged $33.06 in the fourth quarter this year, $10.98 or 24.9 per cent lower.
So why did the shares vest? In colloquial terms, BHP's answer is that if you think it was roughed up in the global sharemarket rout that occurred in 2008 and 2009, you should see the other guys.
It's all about relativities. The long-term incentives are triggered if BHP's total shareholder return (TSR) - that's share price movements combined with dividends - meets or beats a peer group of companies by a certain percentage. The peer group includes obvious mining competitors including Rio Tinto, Vale of Brazil, Xstrata and Anglo American, and three independent oil and gas groups: Apache, BG Group and Devon Energy. BHP outran it over the five-year period: beat it by enough, in fact, for every share created in 2008 to vest this year.
The problem - one BHP's remuneration committee has attempted to address by unilaterally cutting the size of the disgorgement - is that the Australian group's outperformance was in absolute terms actually less serious underperformance.
BHP was measuring itself only against mining and oil gas companies in 2008. It expanded the sample in 2010 by loading in the MSCI world share index that tracks 1500 listed global companies, but the mission for its top executives remained the same.
They must match the total five-year return of the peer group to get long-term incentive shares flowing. The number of shares that do flow depends on how much BHP beats its peer group by, but if it outperforms by an average of 5.5 per cent a year or 30.7 per cent over the five-year period, all shares will vest.
The share price is the dominant driver of the TSR, and as the share price comparison above suggests, BHP's TSR between the March quarter of 2008 and the March quarter this year was negative, at minus 9.4 per cent. The TSR of the peer group was, however, much worse, at minus 44 per cent. BHP outperformed by 34.6 per cent, beating the 30.7 per cent upper boundary of the long-term share scheme, and triggering 100 per cent vesting.
The board's remuneration committee is chaired by John Buchanan, a former BP senior executive, and includes former Goldman Sachs partner and managing director Carlos Cordeiro, former chief executive of South Africa's Sasol Pat Davies, and senior Australian company director John Schubert.
BHP consults with major shareholders about remuneration and other sensitive issues before its annual meetings in October, and the long-term scheme became a focus this year as it became clear the group would register a negative five-year TSR for the first time since the scheme's inception in 2004, while also comprehensively outperforming the peer group. Institutional shareholders were sounded out about the activation of the committee's reserve power to alter the vesting terms, and interaction between the remuneration committee and the full board intensified. The decision, backed by most of the big shareholders that BHP consulted, is to cull the disgorgement by 35 per cent, to 65 per cent of the potential total. Mackenzie is included in the cull, and an offer from him to give up another 50,000 shares was accepted by the board: his 2008 "dividend" fell in total by 207,838 shares or 46 per cent.
BHP said the committee decided to cull entitlements as it felt that "more closely aligning the experience of shareholders and executives was important", but Mackenzie, for example, still gets 243,126 shares worth about $8.6 million, and that raises an obvious question: should BHP's top executives get bonus shares when the group's shareholders go backwards?
There are two possible answers. The simple one is that companies aim to retain talent. The withdrawal of bonuses that have been earned risks losing it.
The longer one is that if BHP doesn't go backwards as badly as its peers, it goes forward. It creates value, relatively speaking.
This "value" is not actually in the bank, however, and a large industry has emerged in the investment world in the past two decades based on "absolute return" methodology, where investment managers receive bonuses only if they deliver positive returns.
The idea hasn't spread far into corporate remuneration schemes, however, and the argument against is that absolute returns introduce factors that management cannot influence. Managers good and bad were whacked by the global financial crisis, for example, and those who coped best arguably should be rewarded.
There's no doubt that relative to the other big companies in its markets, BHP is stronger now than it was when the crisis began. By clipping the long-term bonus without killing it, the board is recognising that fact.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
BHP announced it had disgorged a total of 1,225,438 long‑term incentive shares for chief executive Andrew Mackenzie, former CEO Marius Kloppers and five other past and present executives. Those shares were valued at about $43.6 million on the day of the announcement.
BHP's scheme is based on relative performance. Long‑term incentives vest if BHP's total shareholder return (TSR) meets or beats a peer group by a set margin. Over the five‑year measurement period BHP outperformed its peer group by enough to trigger 100% vesting, despite its absolute share price being lower than in 2008.
TSR combines share price movements and dividends to measure returns to shareholders. Between the March quarter of 2008 and the March quarter in the measurement year BHP's TSR was minus 9.4%, while the peer group's TSR was much worse at minus 44%. That relative outperformance (about 34.6%) exceeded the scheme's threshold and triggered full vesting before the committee applied a discretionary reduction.
The peer group included major mining competitors Rio Tinto, Vale, Xstrata and Anglo American, plus three independent oil and gas groups — Apache, BG Group and Devon Energy. In 2010 BHP expanded its sample by loading in the MSCI world share index that tracks about 1,500 listed global companies.
The scheme pays out fully if BHP outperforms the peer group by an average of 5.5% a year — which is 30.7% over the five‑year period. The number of shares that flow depends on how much BHP beats the peer group by; meeting or exceeding the 30.7% five‑year boundary triggers 100% vesting.
Although the scheme triggered full vesting on a relative basis, the remuneration committee felt it was important to better align executives' outcomes with shareholders' experience. After consulting major shareholders, the committee exercised a reserve power to cull entitlements by 35%, so executives received 65% of the potential total.
After the committee's reduction, Andrew Mackenzie still received 243,126 shares worth about $8.6 million. He also offered to give up an additional 50,000 shares, which the board accepted. In total his 2008 'dividend' entitlement fell by 207,838 shares, or 46%.
Supporters of relative vesting argue companies must retain talent and that rewarding executives who outperform peers — even in a down market — reflects value created relative to competitors. Critics point to the 'absolute return' approach used by some investment managers, where bonuses are paid only when returns are positive; however, BHP's article notes absolute return criteria haven't spread widely in corporate pay because they introduce factors managers can't control, such as the impact of broad market shocks like the global financial crisis.
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