16. Remuneration of Directors and Senior Executives Flashcards
(18 cards)
Why is remuneration important in Corporate Governance?
- Companies need to attract and retain talented executives.
- Remuneration incentives can be used to motivate executives to achieve better results for the company.
- Those incentives need to be aligned with the interests of shareholders and promote the success of the company.
- Directors should not be rewarded for failure.
- Directors should not be able to decide or influence their own Remuneration.
- High levels of executive pay undermines public trust in large businesses.
What are the two elements of remuneration?
- Fixed (regardless of performance) e.g. basic salary and pension scheme payments
- Variable (performance based) e.g. bonus (short-term incentive), share options and other long-term incentive schemes (long-term performance)
Measurements of performance - examples
- Earnings per share (EPS)
- Total shareholder return (TSR) Share price & Dividend
- Profit PBIT (profit before interest & tax) or EBITDA (earnings before interest, tax, depreciation & amortisation)
- return on capital employed (ROCE)
- Others (including non financial)
What are the problems with linking rewards to performance?
- Selecting the right performance measures
- Setting the thresholds at which rewards are paid
- Deciding whether to place a cap on any rewards under the incentive and determining the level of that cap
- Ensuring that the targets used for short term incentives like the annual bonus promote the long term success of the company
- Ensuring that the targets used for incentive schemes do not promote bad behaviour
- Preventing executives who did not perform well from piggybacking on the success of their colleagues
- Preventing the ‘legacy effect’ (when someone leaves but new director benefits from leavers work)
- Executives may develop an expectation that they should receive annual rewards regardless of actual performance of the company
- Designing a scheme that will be satisfactory to shareholders.
Drawbacks of share option scheme
- Share options rewards holders for increases in the share price, when this may not always relate to the executives or the company’s performance (i.e. bull market)
- When the stock markets are in a bear run and prices are declining, share options lose value, and may even become worthless, irrespective of executives or the company’s performance
- Option holders do not benefit from dividend payouts
- The market price of a company’s shares may fall below the exercise price for its share options (‘underwater’)
- Executives directors may prefer a long-term incentive scheme involving the grant of shares, since the shares will always have some value once they have vested.
Principles of remuneration in the Corporate Governance Code 2018
P. Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success. Executive Remuneration should be aligned to company purpose and values and be clearly linked to successful delivery of the company’s long-term strategy.
Q. A formal and transparent procedure for delivering policy on executive Remuneration and determining director and senior management Remuneration should be established. No director should be involved in deciding their own Remuneration outcome.
R. Directors should exercise independent judgement and discretion when authorising Remuneration outcomes, taking account of company and individual performance, and wider circumstances.
Wates Code and Remuneration
Principle 5 - A board should promote executive Remuneration structures aligned to long-term sustainable success of a company, taking into account pay and conditions elsewhere in the company.
- Remuneration for directors and senior managers should be aligned with performance, behaviours, and achievement of company purpose, values and strategy.
- the board should establish clear policies on Remuneration structures and practices which should enable effective accountability to shareholders.
Provision 32, UKCGC2018 (composition of remuneration committee)
“The board should establish a remuneration committee of independent non-executive directors, with a minimum membership of three, or in the case of smaller companies, two. In addition, the Chair of the board can only be a member if they were independent on appointment and cannot chair the committee. Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.”
Provision 33, UKCGC2018 (duties of remuneration committee)
“The remuneration committee should have delegated responsibility for determining the policy for executive director remuneration and setting remuneration for the chair, executive directors and senior management. It should review workforce remuneration and related policies and the alignment of incentives and rewards with culture, taking these into account when setting the policy for executive director remuneration.”
What are the issues of using remuneration consultants?
- may have conflicts of interest by virtue of the fact they are also engaged by the executives to advise the company on other aspects of remuneration or may have another connection with an individual director (e.g. an executive director who serves on another company’s remuneration committee)
- there is a risk that they will make recommendations which favour the executive directors and not necessarily in the best interests of the company.
- may be inclined to recommend complex remuneration schemes in order to increase their fees and make it more difficult for the remuneration committee to dispense with their services in future years.
- may put pressure on the remuneration committee to accept their advice (e.g. by failing to come up with a credible alternative).
- executive directors and senior management may also put pressure on the remuneration committee.
Provision 35, UKCGC2018 (Remuneration consultants)
- the remuneration consultants should be identified in the annual report alongside a statement about any other connection they have with the company or individual directors.
- remuneration committee members should exercise independent judgement when evaluating the advice of external third parties and when receiving views from executive directors and senior management.
Provision 41, UKCGC2018 (remuneration committee report)
In the remuneration committee report, there should be a description of the work of the remuneration committee in the annual report which should include:
- an explanation of the strategic rationale for executive directors’ remuneration policies, structures and any performance metrics
- reasons why the remuneration is appropriate using internal and external measures, including pay ratios and pay gaps
- a description, including examples, of how the remuneration committee has addressed the factors in provision 40 (clarity, simplicity, risk and predictability).
- whether the remuneration policy operated as intended in terms of company performance and quantum, and of not, what changes are necessary
- what engagement has taken place with shareholders and the impact this has had on remuneration policy and outcomes
- what engagement with the workforce has taken place to explain how executive Remuneration aligns with wider company pay policy
- to what extent discretion has been applied to remuneration outcomes and the reasons why.
Listed vs quoted companies
Listed companies = those listed on the London stock exchange (Main market)
Quoted companies = those listed on any stock exchange (includes AIM companies and Main market)
Annual Remuneration Report (s.420 CA2006)
Quoted companies (Main and AIM) are required to make detailed disclosures regarding directors’ remuneration in a separate section of the annual report known as the annual “Directors’ Remuneration Report” and must include:
- the directors remuneration policy of the company if that policy is to be put to shareholders for approval at the AGM; and
- an annual implementation report giving details of remuneration payments (and any payments for loss of office) made to directors in the relevant financial year under the policies that applied during that year or previous years.
Annual vote on remuneration (s.439 CA2006)
- the annual Remuneration Report of a quoted company must be put to an annual vote by shareholders at the AGM
- if the resolution is defeated, the directors must put the existing directors’ remuneration policy or a revised policy to a vote at the next AGM
- the directors must invite shareholders to approve their policy at least once every three years whether or not it has been revised and must obtain shareholder approval for any revised policy before they can make any payments under that new policy.
Compensation for loss of office
CA2006 introduced a new threshold for directors service contracts which nows states that they must not exceed two years duration without shareholders approval, compared to five years previously (s.188).
Provision 39, UKCGC2018 - Notice or contract periods should be one year or less. If it is necessary offer longer periods to new directors recruited from outside the company, such periods should reduce to one year or less after the initial period. The remuneration committee should ensure compensation commitments in directors terms of appointment do not reward poor performance. They should be robust in reducing compensation to reflect departing directors’ obligations to mitigate loss.
Malus and clawback
Provision 37, UKCGC2018 - Remuneration schemes and policies should enable the use of discretion to override formulaic outcomes. They should also include provisions that would enable the company to recover and/or withhold sums or share awards and specify the circumstances in which it would be appropriate to do so.
“Malus” provisions allow the company to forfeit all or part of a bonus or long-term incentive award before it has vested and been paid (aka performance adjustment).
“Clawback” provisions allow a company to recover sums already paid.
The current market standard triggers for malus and clawback are gross misconduct or misstatement of results.
Provision 34, UKCGC2018 (NED Remuneration)
The remuneration of non-executive directors should be determined in accordance with the Articles of Association or, alternatively, by the board.
Levels of remuneration for the chair and all non-executive directors should reflect the time commitment and responsibilities of the role.
Remuneration for all non-executive directors should not include share options or other performance related elements.
