What is the role of the remuneration committee?
Rewarding executives requires informed judgement. Remuneration committee members do not need expert knowledge, but they do need data to make sound decisions on levels of remuneration, on the link between remuneration and performance, and on the structure and cost of all elements of the executive package.
Remuneration committees need to have a thorough understanding of their company and the forces that shape directors’ remuneration.
Understanding the business
Directors’ remuneration levels vary greatly from business to business. The key factors in decision-making are listed below.
Size can affect all aspects of pay – base salary levels, annual bonus design, performance measures and the type of long-term incentive plans that are appropriate. But it is a variable concept. It can be measured in terms of revenues, capital employed, margins or financial structures. Market capitalisation is seldom the main factor in directors’ remuneration.
Performance record and prospects
Is the company a new business, an established business with a steadily improving performance, a business that is going through a recovery or a turnaround? Are there clear strategic challenges to address? Is it fast growing with an unpredictable future, or stable with limited but fairly certain prospects?
Both business sector and the position of a business within it are significant.
Internationalisation, complexity and innovation
Should the companies all follow UK pay norms? How should they accommodate US or European pay norms for their overseas directors? Should the pay of directors in international or high-technology companies differ from that of directors in companies of equivalent size that operate only in the UK, or in low-technology or regulated industries?
Cashflow and debt levels
Both of these might place an important limitation on smaller organisations where the pay of directors can be a significant proportion of business costs.
Key performance measures
These should provide the essential underpinning when it comes to designing incentives, be they short or long term. What are the important performance measures associated with increasing shareholder value? How is the company doing in comparison with its competitors on these measures? What are the critical short-term and long-term indicators of performance?
Understanding company culture and values
Every organisation has its own culture and values and these are frequently reflected in remuneration, whether in the design of incentives, the type of benefits available or, indeed, the level of remuneration itself. Outside directors need to be able to recognise deeply held values that are associated with success and to avoid cutting across these values when it comes to remuneration arrangements.
Understanding current arrangements
Remuneration committees are rarely given the luxury of starting from a clean slate. Before the first meeting, it is useful to get a full briefing from fellow committee members, the chief executive or the human resources director. In particular, the committee must know:
- The overall remuneration philosophy – the positioning of total remuneration relative to the market place, the definition of the market place, the approach to short-term and long-term incentives, the benefits policy, etc.
- Contract details – notice periods, severance arrangements, compensation for loss of office and special arrangements (if any) in relation to changes of control.
- Details of individual directors’ remuneration for the past three to five years – including base salary, bonuses, long-term incentive grants and exercise values.
- How far current remuneration complies with ABI and NAPF guidelines.
- Any immediate changes planned (eg as a result of the expiry of a share option plan, or a change in the strategy of the business).
- Any special arrangements for individual directors and why they exist. New hires or executives approaching retirement, for example, might have been offered something different.
- The market information provided by advisers.
- How outside advisers were appointed, who they are, and why they were selected.
Understanding stakeholder interests
Within the confines of the law and Stock Exchange listing requirements, directors’ remuneration is chiefly a matter for the company, its shareholders and executives. However, decisions are closely watched by a wide range of other people and institutions. Executive pay can come under fire when an interest group’s view of the company clashes with the way the board is being rewarded. As a result, understanding interest groups and their perceptions of the company is vital in ensuring smooth implementation of remuneration committee recommendations.
Understanding the market
The final element of preparation is to understand markets and market data. Both the Greenbury and Hampel reports made much of the use and abuse of data, and cautioned remuneration committees to take particular care in their use of surveys.
However, market data is an important input into remuneration committee deliberations. Market data is there to be questioned and interpreted. It defines the parameters of normality – the boundaries of what is reasonable.