Remuneration of Directors and SM Flashcards
Why is remuneration an important CG issue? (5)
- Companies need to attract and retain talented executives = Remuneration helps to achieve this
- 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 = difficult
- directors should not be rewarded for failure
- High levels of executive pay undermine public trust in large businesses
What are the 5 components of a remuneration package for a director or senior executive?
- basic salary;
- payments into a pension scheme
- an annual bonus, usually linked to the annual financial performance of the company;
- long-term incentives = share options or share awards
- other benefits and perks = a company car
What are the 2 elements that remuneration can be divided into?
What are the further 2 elements of the second one?
- The fixed element = the remuneration received by the director regardless of performance e.g. their salary and pension contributions
- The variable element = performance-related incentives e.g. cash bonuses, share options
- The variable elements of pay can be divided into:
1. short-term incentives = cash bonuses based on annual performance targets
- Long-term incentives = share options may be awarded each year, but are typically linked to performance over a longer period of 3+ years
What are short-term performance-based incentives?
What are the 6 different ways to measure financial performance?
= reward executives if actual performance during a review period reaches or exceeds certain predetermined targets = usually linked to the financial year
- earnings per share
- annual profit before interest and taxation (PBIT);
- total shareholder return (TSR)
- earnings before interest, taxation, depreciation and amortisation (EBITDA);
- return on capital employed (ROCE);
- other KPIs e.g. net income
What are long-term incentive share options?
What is the exercise price and what do the Listing Rules say about this?
Will the executive get a benefit if the share price remains below the exercise price?
= Each option gives the holder a right to buy a new share in the company at a fixed price on or after a specified date in the future, provided that they are still in their job at that time
Exercise price = the purchase price for the new shares under the option
* Listing Rules = the exercise price for options given to directors must not be less than the current market price
With share options, the executive gets no benefit if the share price remains below the exercise price
What are long-term incentive share grants?
When does the director receive the shares and acquire ownership over them?
How should share awards be released for sale according to provision 36?
Will the executive get a benefit if the share price remains below the exercise price?
= directors given existing shares in the company after a specified period of time, typically 3 years (provided that they are still in their job)
= Not at the time of grant, only when the shares vest = will be conditional on the achievement of certain performance targets during that time
Provision 36 = released over a phased basis and total vesting and holding period of 5+ years.
With share grant schemes = the executive benefits even if the share price falls, because the shares still have some value
What are the 6 practical problems with devising a satisfactory remuneration scheme that links rewards with performance?
- Selecting the right performance measures
- Setting the thresholds at which rewards are paid = challenging but not unobtainable and disincentivizing
- Deciding whether to place a cap on any rewards and determining the level
- Ensuring targets for short-term incentives promote the long-term success of the company
- Ensuring targets used for incentive schemes do not promote bad behaviour
- Designing a scheme that will be satisfactory to shareholders
An excessive use of options can result in a serious misalignment of interest between shareholders an directors.
What are the 4 drawbacks of share option schemes?
- Option holders do not benefit from dividend pay-outs. EDs may have interest in keeping dividends low
- Share prices are volatile = Option holders may be unjustly benefit in a bull market and be inadequately rewarded in a bear market (both disincentivizing performance)
- EDs may prefer a long-term incentive scheme involving the grant of shares, since the shares will always have some value once they have vested
- IFRS2 Share-based Payment requires companies to recognise the award of share options as an expense, chargeable against the company’s profits = may discourage some companies from using options as an incentive.
What does the UK CG Code say on directors being involved in setting their own remuneration?
What does this mean in practice?
No director should be involved in deciding their own remuneration:
Principle Q = a formal and transparent procedure for developing policy on executive remuneration and determining director and senior management remuneration should be established’.
In practice this means setting up a RC (Provision 32)
What are the composition requirements of the remuneration committee under Provision 32? (3)
- Consist exclusively of INEDs (3 in large companies, 2 in smaller companies)
- Company chair can serve on the RC if they were considered independent on appointment as chair (cannot chair committee)
- Chair of RC must have served on RC for at least 12 months before appointment as committee chair
What are the duties of the remuneration committee according to Provision 33 UK CG Code? (2)
Under this Provision, what should the committee review when setting the policy for executive director remuneration’?
Provision 33 states that the RC should have delegated responsibility for:
1. determining the policy for ED remuneration; and
2. setting remuneration for the chair, EDs and senior management
Committee should ‘review workforce remuneration and related policies and the alignment of incentives and rewards with culture
What does Provision 35 say on remuneration consultants? (3)
Why does the Provision require these things?
What are 4 issues that may arise with remuneration consultants?
- where remuneration consultants are appointed, this should be the responsibility of the RC
- The remuneration consultants should be identified in the annual report alongside a statement about any connection they have with the company or individual directors
- RC should exercise independent judgement when evaluating the advice of external 3rd parties and when receiving views from EDs and senior management
= reflects concern about potential conflicts of interest remuneration consultants may have which may compromise their objectivity
- May have conflicts of interest if engaged by EDs to advise the company on other aspects of remuneration
- Risk they will make recommendations that favour EDs and not in best interests of company
- May be inclined to recommend complex remuneration schemes to increase their fees (and ensure company becomes reliant on them in the future)
- May put pressure on the RC to accept their advice (e.g. by failing to come up with any credible alternative).
REMUNERATION COMMITTEE REPORT
What are the 2 things the annual remuneration committee report of a quoted company is required to include under the statutory disclosure regime?
Which UK CG Code Provision includes a list of things that must be included?
- Details regarding the membership of the remuneration committee and any advisers.
- A statement by the RC chair summarising the major decisions and changes made in relation to directors’ remuneration during the year
Provision 41
DIRECTORS’ REMUNERATION REPORT
Which companies are required to produce a Directors’ Remuneration Report?
What 2 things must the report include?
S.420 CA2006 = quoted companies
- Report must include:
1. the directors’ remuneration policy IF the policy is to be put to shareholders for approval (3 occasions = changes/new policy, 3 years, and implementation report resolution not approved at last AGM); and
- the annual remuneration report (=implementation report) containing information on how the remuneration policy was implemented during the year = describe remuneration payments made to directors (including loss of office)
DIRECTORS’ REMUNERATION POLICY
Name 3 components of the directors’ remuneration policy.
When must the directors’ remuneration policy form part of the directors’ remuneration report? (3)
What are the consequences if the remuneration policy isn’t approved?
- A table describing each component of the remuneration package that may be offered to directors under the policy
- A statement of the principles applied
- A statement on whether and, if so, how shareholders’ views expressed to the company were taken into account in formulating the directors’ remuneration policy
1.If it has been three years since the policy was last approved by shareholders
2.If the company wishes to revise the policy
3.If the annual remuneration report (implementation report) was not approved by an advisory vote of shareholders at the previous AGM
s.226A and 226B CA2006 = A quoted or traded (not including AIM) company cannot make any payments to a director unless they are consistent with the latest policy approved by shareholders or the payment has been specifically approved by shareholders
