Extracting value?

For investors focused on long-term outcomes, the structure of executive incentive plans is critical. While much attention is given to the size of long-term awards, the method of vesting of these awards is more important. In sectors where there is a clear link between executive performance and share price over the medium term[1], attaching appropriate vesting criteria is challenging enough, but remuneration committees at extractives face an even harder task. In extractive industries, external factors – particularly commodity prices – often have a greater impact on share price than management actions; even relative performance measures can be distorted by differences in commodity mix and financial or operational leverage.

We recognise the challenges remuneration committees face in the mining and extractive sectors, where long-term plans often operate on relatively short cycles compared to the time horizon for strategic decisions to deliver results. Recently, some extractive companies have sought our views on shifting from performance-based schemes to time-based share awards (RSUs). We do not support this direction in the extractives industry.  

Instead, we believe that long-term incentive plans should replace outcome-based measures (like absolute or relative share price performance) – which we agree are often outside of executive control – with strategic input measures (such as consistent delivery of long-term cost and productivity measures or innovation milestones). These strategic input metrics should be supported by robust mechanisms such as clawbacks, vesting into deferred shares with extended holding periods, and meaningful stock ownership requirements, ideally extending post-exit, to ensure sustained alignment with long-term shareholder value. These strategic input measures should be measurable[2], meaningful[3]¸ challenging to deliver[4] and long-term[5]. 

We believe that achievement of specific strategic input measures that reflect the drivers of long-term success – rather than relying solely on traditional financial outputs – will reward executives for positioning the company towards long-term value creation and can effectively incentivise the behaviours that potentially lead to sustained financial outperformance. We recognise that there is no one-size-fits-all approach to remuneration – each company’s incentive structure must reflect its unique strategy and context. Boards should identify the performance objectives most relevant to their business model and long-term vision. For example, one company might target delivery of a long-term greenfield project on time and on budget, while another might target the addition of new resources and delivery on long-term productivity improvements. 

It goes without saying that, for highly carbon-intensive companies like those in the extractive industry, we would expect sustainability factors – such as climate change and health and safety – to play a meaningful role in these strategic input metrics – and a much more meaningful part than they tend to take up in incentive schemes today. We view climate considerations as an integral part of corporate strategy and long-term value creation for companies in these sectors. We therefore recommend that climate targets make up at least 20% of long-term share incentives. We think the best schemes are likely to be those that are simple, easy to understand, can be applied with some variability to many layers of a company’s management team, and which incentivise performance against a relatively small number of objectives rather than a large score card of complex measures. 

During these consultation processes, as we have proposed this sort of approach to board directors, we have received strong pushback. In particular, we have been alarmed to be told that our views on this matter are significantly out of step with other investors. This surprises us – and we would like to hear from our peers and asset owners who disagree with this approach. It may be that we have overlooked some important factors or arguments – and would welcome engagement on this important issue. The extractive industry is too important to our portfolios, the world and the energy transition for us to not get this vital issue right. 

The contents of this blog are intended to complement our existing remuneration policies, which can be found on the Investment Stewardship website. For more detail on our approach, please refer to our published policies on executive pay across different markets, including our UK, US, and global policies.

Whilst L&G has integrated Environmental, Social, and Governance (ESG) considerations into its investment decision-making and stewardship practices, this does not guarantee the achievement of responsible investing goals within funds that do not include specific ESG goals within their objectives.

[1] Roughly five years.
[2] Objectively, with clear quantitative metrics that are hard to manipulate or distort over short- and medium-term time periods, and which ideally directly tie back to targets that have been presented to investors. 
[3] Targets should be factors which in the view of the board are the primary controllable drivers of corporate performance over the medium-term time period – they should be meaningful to investors. 
[4] It should be demonstrated that delivering and outperforming against these targets is challenging – and that there should as far as possible be a ceteris paribus correlation between the level of performance against the objective and what would have been considered upper quartile performance under more traditional schemes.  
[5] An input-based LTIP scheme should be complementary to, not duplicative of, the objectives attached to annual incentive structures – so that the performance that is being targeted is fundamentally long term in nature (like delivery against multi-year cost or productivity targets, for example).