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APG Asset Management Compensation guidelines.

APG has recently published its Compensation guidelines introducing –as they say- a buy-side perspective on the matter.

We refer to this document (1) in this post, as we consider this a very valuable initiative and a very insightful view of what investors really think an adequate Pay Policy needs to be.

The first clue to their approach appears when they state that value creation for shareholders is the added economic value in excess of the cost of capital. So compensation should in their view incentive both an efficient asset use and an efficient capital allocation and capital growth process.

Their guidelines refer to:

  1. Pay structure, and
  2. Performance drivers

Pay Structure

Besides value creation as defined above, APG refers to other continuity and performance resilience pay objectives, that every company should enhance through an adequate relationship with other stakeholders, (environment, social and other aspects of operations) and perhaps including some related metrics in the compensation arrrangements in order to incentive these objectives.

Although setting the strategy, the goals for managers and the corresponding incentives is the main Remuneration Committee task, some “justified” discretion by the board is accepted by APG.

The policies should also be clearly disclosed, in a way that the objectives determined for managers, the performance and connection between pay and performance become easy to understand.

Four principles should guide the boards:

  1. Business strategy is to be served, not the market best practices. Performance metrics need to be connected to the value drivers (and preferably not TSR) and the company`s risk profile.
  2. Pay policies should be tied to shareholders`s long-term interests, and inevitably those of other constituents. This implies encouraging shareholding by managers, holding obligations in time, even after departure; using strategy value drivers as metrics, and careful case by case study of recruitment and departure payments.
  3. Pay levels and differentials within the firm should be those necessary for succesful operations, pay structures should be simple and allow to moderately increase fixed pay for managers.
  4. Time should be considered: timing of awards, length of the performance period, time to vesting and holding periods….should all be linked to the strategic and capital cycles of the company, (whatever the overall market practices are, a board should know what the specific company needs).

Performance Drivers.

The company intrinsic value is linked to its cash flows and cost of capital, whereas the cash flows stem from operational returns and growth, so APG strongly recommends that performance metrics refer to these two parameters.

And the ability of a company to persist in creating value can be judged by a combination of financial and non-financial measures, that each company should correctly select.

Finally, APG expects companies to keep their pay structures quite stable through time, (if pay schemes are linked to their particular circumstances, this is quite reasonable), and to base their pay schemes on rigorous and stable definitions and calculation methods, use return measures on unimpaired capital levels, and derive metrics transparently from the books.

(1) The document can be downloaded here: http://www.apg.nl/nl/pdfs/apg-remuneration-guidelines-to-listed-european-companies.pdf

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