Explain and analyze the legal, ethical, competitive and regulatory issues associated with directors’
remuneration
Directors' remuneration
Remuneration is defined as payment or compensation received for services or employment and
includes base salary, any bonuses and any other economic benefits that an employee or executive
receives during employment.
Behavioral impact on directors of remuneration components
Whatever remuneration package is determined, it is essential to ensure that the directors have a stake
in doing a good job for the shareholder.
Each element of a remuneration package should be designed to ensure that the director
remains focused on the company and motivated to improve performance.
A balance must be struck between offering a package:
o that is too small and hence demotivating and leading to potential underachievement,
and
o That is too easily earned.
There are a number of issues relating to directors' remuneration which a company should consider.
These are:
Legal: what are the legal implications of the company/director relationship in terms of
remuneration, especially when things go wrong?
Ethical: what ethical considerations should a company have in setting directors' remuneration?
Competitive: how does a company remain competitive and ensure that they attract good quality
directors?
Regulatory: what are the regulatory requirements that a company should adhere to in relation
to its directors' remuneration?
Legal
A company (with the guidance of the remuneration committee) should:
carefully consider what compensation commitments (including pension contributions and all
other elements) their directors' terms of appointment would entail in the event of early
termination
Aim to avoid rewarding poor performance.
Ethical
The traditional view that ethics and business do not mix is now rarely accepted.
Increasingly companies are demonstrating sensitivity to combining ethical issues with
commercial success.
The commercial environment is progressively affected by the very ethical issues that companies
are now dealing with.
The 2006 Companies Act in the UK makes it a legal requirement for directors to act as 'good
corporate citizens', in effect, that directors pay attention to the ethical effects of company
decisions.
Public reaction to high profile corporate failures where directors were receiving what was
perceived as excessive remuneration in relation to their performance.
Public perceptions of excessive pay rises in underperforming companies and privatised utilities.
Recent changes to best practice disclosure requirements on board structure and executive pay
have put pressure on companies to change their board policies to be seen to be in line with
accepted best practice.
The following recent developments have resulted in many leading companies incorporating
business ethics into their management processes, directors' employment contracts and
performance- related pay systems.
Competitive
It is vital that a company has a proficient, motivated board of directors working in the interests of its
shareholders and that it can recruit and retain the individuals required for successful performance.
A balance must be struck with regards to the overall remuneration package.
If it is too small:
Unattractive for potential new appointees, hence a failure to recruit required caliber of
individual.
Demotivating for existing directors, hence potential underachievement.
If it is too big:
Too easily earned, hence shareholders not getting 'value for money' in terms of performance.
Regulatory
The UK Directors' Remuneration Report Regulations 2002 require that:
directors submit a remuneration report to members at the annual general meeting (AGM) each
year
the report must provide full details of directors' remuneration
the report is clear, transparent and understandable to shareholders
Where a company releases an executive director to serve as a NED elsewhere, the remuneration
report should include a statement as to whether or not the director will retain such earnings
and, if so, what the remuneration is.
There is an increasingly regulatory environment for companies to operate in and this in turn is placing
greater demand on directors.
Remuneration packages in general have risen in the wake of recent high profile corporate
scandals and the passage of the Sarbanes-Oxley Act 2002 (SOX).
This reflects:
o the additional demands on directors
o the additional responsibilities of directors
o the potential liability of those individuals who agree to serve on boards of directors
o Heightened external scrutiny.
