16 - Remuneration of directors and senior execs

Question 1

6 reasons why remuneration is such an important CG issue

Answer 1

• Remuneration is a very important aspect of attracting and retaining talented execs
• Remuneration incentives can be used to motivate executives to achieve better results for the company
• It is pivotal to not reward directors for failure
• Incentive schemes need to be aligned with interests of shareholders
• High levels of exec pay can undermine public trust
• Directors should not be able to decide or influence their own remuneration

Question 2

5 components of executive remuneration

Answer 2

• Basic salary
• Payments into pension scheme
• Annual bonus
• Long-term incentives - share options and share grants
• Other benefits - such as company car

Question 3

2 elements of remuneration pay that components can be divided into

Answer 3

• Fixed
• Variable

Question 4

Which components of remuneration make up fixed element?

Answer 4

• Salary
• Pension contributions
• Other benefits

Question 5

What can variable element of remuneration pay be divided into?

Answer 5

• Short-term incentives - usually cash
• Long-term incentives - share options or share grants

Question 6

How are annual bonus payments typically achieved?

Answer 6

Meeting financial performance targets

Question 7

5 KPIs for financial performance re. short term remuneration

Answer 7

• EPS (profits divided by shares in issue)
• Profit before interest and taxation (PBIT)
• Total shareholder return (dividend and share price appreciation)
• Earnings before interest, taxation, depreciation and amortisation (EBITDA)
• Return on capital employed (ROCE)

Question 8

Explain deferred annual bonus schemes

Answer 8

Company may offer to provide annual bonus either in full or part as shares in the company. Usually held on trust for 3 years

Question 9

Why is a share option a long-term incentive for execs?

Answer 9

Exercise price is fixed, typically at market value at time of issuing. The more that the share price rises before the option is exercised, the more of a good deal (and opportunity for immediate profit) the director gets.
Typically 10 year max on exercising

Question 10

Explain grants of shares

Answer 10

‘Performance shares’, ownership of which will be conditional on achievement of targets.
Closer to target, higher % of shares awarded

Question 11

2 most common performance measures for long-term incentives

Answer 11

EPS & TSR
Grant Thornton CG Review 2018

Question 12

9 problems/considerations in linking remuneration with co’s performance

Answer 12

• Whether to include non-financial targets
• Setting thresholds (obtainable but challenging)
• Whether to place a cap
• Ensuring targets promote LT success
• Ensuring targets do not promote bad behaviour
• Difficulties in isolating each execs performance
• Difficult to prevent new execs benefitting from legacy effects
• Directors may expect rewards regardless of success
• Major shareholders should consider scheme satisfactory

Question 13

Use of comparative pay data in remuneration

Answer 13

Companies may decide to base fixed and/or variable remuneration on that of competitors

Question 14

Issue to consider with comparative remuneration pay

Answer 14

If all companies in comparative group decide to pay above average pay, pay will spiral up and up

Question 15

3 drawbacks to using share options for long-term incentive schemes

Answer 15

• Shareholders may prefer dividends, and execs may have interest in keeping dividends low until options are exercised
• Share prices may rise in line with general stock market rise, rather than co’s success (vice versa)
• Share option will not provide any incentive if share price drops

Question 16

Meaning behind provision 35 - ‘Independent judgement should be exercised when evaluating advice of third parties [on remuneration]’

Answer 16

Remuneration committee should not blindly follow recommendations of remuneration consultants

Question 17

According to Code, should NEDs’ remuneration be performance based?

Answer 17

No

Question 18

How does UKCG Code define ‘senior management’

Answer 18

The executive committee or the first layer of management below board level (including the CoSec)

Question 19

Are the board responsible for remuneration consultants?

Answer 19

No, the remuneration committee are

Question 20

3 main concerns over remuneration consultants

Answer 20

• Objectivity
• Believed to have played role in promoting spiralling exec pay
• Intentionally complex

Question 21

3 reasons behind concerns on remuneration consultants

Answer 21

• CoIs if engaged by execs to advise on other aspects or if connected to an exec, meaning they may make recos which favour execs over company
• Inclined to recommend complex schemes to raise their fees and make them harder to dispense of
• Execs, senior management and consultants themselves may put pressure on rem com to accept advice

Question 22

Rem Com report for quoted co’s must include: (2)

Answer 22

• Details regarding membership of committee
• Statement summarising major decisions made in relation to remuneration, and context

Question 23

Quoted companies reporting requirements on remuneration under CA 2006

Answer 23

Directors’ remuneration report, including:
- the remuneration policy if it is to be put to shareholders
- Annual remuneration report giving details of payments

Question 24

Maximum time that quoted or traded co can go without having remuneration policy approved

Answer 24

3 years (even if no changes)

Question 25

Where must remuneratIon policy be made available

Answer 25

Company's website

Question 26

Difference between directors' remuneration report and annual remuneration report

Answer 26

Annual remuneration report is 1 of 2 components of director's remuneration report

Question 27

Significance of service contract in terms of pay (2)

Answer 27

- Will provide for annual review of remuneration - Provide for minimum notice period in event of dismissal

Question 28

What does CA 2006 say on length of service contracts?

Answer 28

More than 2 years requires shareholder approval

Question 29

Look at Code - service contracts - 2 key points

Answer 29

- 1 year or less - Compensation commitments should not reward poor performance

Question 30

Which Code provision relates to malus and clawback provisions?

Answer 30

Provision 37

Question 31

What are 'malus' provisions?

Answer 31

Allow the company, in specified circumstances, to forfeit all or part of bonus or long-term incentive award before it has been vested and paid

Question 32

What are 'clawback' provisions?

Answer 32

Allow the company to recover the sums already paid

Question 33

FRC's board effective guidance states circumstances which should allow for 'malus' and 'clawback' (to be decided by rem committee) should include: (5)

Answer 33

- Payments based on erroneous or misleading date - Misconduct - Misstatement of accounts -Serious reputational damage - Corporate failure

Question 34

How are terms of NEDs appointment set out?

Answer 34

In a simple letter of appointment

Question 35

Who sets NEDs fees?

Answer 35

Usually the board, to avoid NEDs on rem com setting own remuneration

Question 36

What form of payment do NEDs usually receive?

Answer 36

Fee for services - cash See Code Provision 34

Question 37

3 reasons why it is considered inappropriate for NEDs to have pay based on co's performance

Answer 37

- Would involve CoI for those on rem com in designing performance schemes - Interests of NEDs would become more closely aligned with execs than shareholders - NEDs do not have such a great impact on co's performance as execs

Question 38

What should fees paid to NEDs reflect?

Answer 38

The time commitment and responsibilities they undertake in the role

Question 39

How often will quoted co's remuneration report be put to a vote by shareholders? - advisory vote

Answer 39

Annually (at AGM)

Question 40

What if remuneration report is rejected by shareholders at 'advisory vote'?

Answer 40

Revised policy needs to be put to next accounts meeting and voted on

Question 41

3 key elements of directors' remuneration policy

Answer 41

- Table describing each component of the remuneration package - Statement of the principles which are applied - Bar chart indicating minimum and maximum amounts

Question 42

5 considerations when approaching setting basic salary levels of directors

Answer 42

- Any remuneration awarded to execs for next FY must be consistent with current remuneration policy approved by shareholders - Remuneration consultants should typically be used - Benchmarking against comparator companies - Consulting with shareholders - Workforce remuneration and consultation

Question 43

Look at Code - what are the primary principles and provisions to consider when reviewing/deciding remuneration?

Answer 43

Principles P & R Provision 40

Question 44

Use of remuneration consultants to assist with determining exec pay (3)

Answer 44

Accepted practice that Rem Com use remuneration consultants to advise on levels of director pay Rem Com should not blindly follow advise and should ultimately apply its own judgement Concerns over rem consultants should be considered (objectivity & role in spiralling remuneration)

Question 45

Use of benchmarking in determining salary levels of execs (4)

Answer 45

Information about the level of salaries of directors of comparator companies can be considered Information is typically provided by remuneration consultants Comparator companies appropriately chosen based on size and business sector Pay structures should not be based solely on benchmarking as this can lead to ratcheting (spiralling) effect on executive pay

Question 46

Importance of consulting with shareholders when determining executive remuneration (2)

Answer 46

20% or more votes against the remuneration report triggers obligation to consult with shareholders under Code Annual report requirement to state what engagement has taken place with shareholders and the impact that had on remuneration outcomes

Question 47

Look at Code - where in code does it state the disclosures in annual report on how remuneration has been set?

Answer 47

Provision 35 & Provision 41

Question 48

Consideration of workforce remuneration and consultation when setting exec remuneration (2)

Answer 48

Rem Com is required under Code (Provision 33) to review workforce remuneration when setting policy for exec remuneration Reference to pay ratios are required when providing reasons why chosen exec pay level is appropriate

Question 49

CA 2006 requirements on directors' remuneration policy

Answer 49

Under CA2006, listed companies must seek approval from shareholders for directors' remuneration policy: at least every three years, if they wish to revise the policy, or if the directors' remuneration report was not approved by advisory vote at previous AGM. A listed company cannot make any payments to a director unless they are consistent with the latest policy

Question 50

Look at code - which provision relates to preventing rewards for failure? What are the two aspects

Answer 50

37 - Malus and clawback - Use of discretion

Question 51

5 considerations when approaching a long-term incentive plan question

Answer 51

- Companies Act restrictions - Code principles and provisions - Preventing rewards for failure (use of discretion and malus and clawback) - Consulting with shareholders - Performance measures

Question 52

Performance measures under an LTIP (3)

Answer 52

Non-financial and financial measures should be considered Remuneration consultants could be used to assist in designing the targets Financial measures - TSR (share appreciation + dividends) - EPS (income / shares in issue) Non-financial measures - Employee retention - Environmental targets - Customer satisfaction

Question 53

3 non-financial measures that can be used for LTIPs

Answer 53

- Employee retention - Environmental targets - Customer satisfaction

Question 54

3 instances whereby remuneration policy must be put to shareholders for approval

Answer 54

- 3 years since policy last approved - Company wishes to revise policy - Directors' remuneration report not approved by advisory vote of shareholders at previous AGM

Question 55

What is the typical performance period considered under LTIPs?

Answer 55

3 years