Remuneration: Hardening Mood on Director Pay
The role of the remuneration committee on UK boards is changing, as the mood hardens on director and executive pay. The main role of the remuneration committee is to set the company’s remuneration policy, determine each executive director’s total individual remuneration package and set the targets for performance-related pay.
The UK Investment Association, in November 2018, updated its guidance for remuneration committees in the country.
The IA makes it clear that companies which fail to respond to shareholder views, or do not take the time to understand those views, will find that investors have no choice but to vote against their remuneration proposals.
“The IA warns that executive remuneration is a reputational issue for the company, individual remuneration committee members and those executive directors who receive remuneration from contentious arrangements. Any boards still taking the view that pay is a contractual matter only and that fairness in remuneration is a woolly, nice to have, concept have been given a very clear warning that the landscape has changed,” writes the London-based law firm Squire Patton Boggs in a note.
Remuneration committees have also become a target of the hardening mood on director and executive pay. On 26 March 2019, the UK Parliament’s Business, Energy and Industrial Strategy Committee (BEIS) published its report “Executive rewards: paying for success,” and it is severely critical of remuneration-committee practice.
The report points out that “huge differentials have been baked into the pay system, in part by a heavy reliance on over-generous, incentive-based pay and partly by the weakness of remuneration committees which design ever more complicated and opaque pay packages for their peers.”
The report also calls for the mandatory participation of an employee representative on the remuneration committee.
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Remuneration Committee and Corporate Governance
While the recommendations of the BEIS report will be debated for some time, there is unquestionable pressure emerging from both regulators and investors for remuneration committees to play a more active role. This will mean revising terms of reference and possibly reconsidering committee composition.
The most recent version of the UK Corporate Governance Code (2018) redefines the responsibilities of the remuneration committee:
“A formal and transparent procedure for developing policy on executive remuneration and determining director and senior management remuneration should be established. Directors should exercise independent judgement and discretion when authorising remuneration outcomes, taking account of company and individual performance, and wider circumstances,” the Code says.
“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.”
Remuneration Committee Terms of Reference
To implement these principles, the first task of the remuneration committee is to define terms of reference.
The Institute for Chartered Secretaries and Administrators (ICSA) proposes a for these terms of reference, which includes:
- The committee must have at least three members, all of whom shall be independent non-executive directors. The chair of the board may also serve on the committee as an additional member if he/she was considered independent on appointment as chair.
- The board shall appoint the committee chair who shall be an independent non-executive director – this shall not be the chair of the board. The company secretary shall act as the secretary of the committee.
- The committee has responsibility for fixing the remuneration policy of all executive directors and the chair of the board. The board or the shareholders determine remuneration for non-executive directors.
Determining policies for remuneration is the job of the remuneration committee, and the Code calls for broader terms of reference.
The objective of such policy shall be to attract, retain and motivate executive management of the quality required to run the company successfully without paying more than is necessary, having regard to the views of shareholders and other stakeholders.
The remuneration policy should have regard to the risk appetite of the company and alignment to the company’s long term strategic goals. A significant proportion of remuneration should be structured so as to link rewards to corporate and individual performance and designed to promote the long-term success of the company.
The remuneration committee must produce a report on the company’s remuneration
policy and practices, and it must be included in the company’s annual report. The chair must discuss remuneration policy at the annual general meeting (AGM), and the report must be put to shareholders for their approval. The chair is also expected to remain in contact with shareholders regarding remuneration throughout the year.
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Remuneration Committee Must Evaluate Its Own Work
The remuneration committee has another important duty: It must evaluate its own work. As ICSA points out: “The committee must arrange for periodic reviews of its own performance and, at least annually, review its constitution and terms of reference to ensure it is operating at maximum effectiveness and recommend any changes it considers necessary to the board for approval.”
Given the extremely sensitive nature of the committee’s work, such self-assessment should be undertaken in conditions of extreme confidentiality. Once the assessment is completed, a broad overview of achievements and points for improvement should be shared with management and shareholders.
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