Directors' remuneration

In the past shareholders were concerned about the large salaries directors awarded themselves despite poor profits.
Controls were needed to reduce this risk and a number of Reports on corporate governance have tried to address
these concerns.

The Greenbury Report (1995) contributed to the existing code with regards to directors' remuneration.

This committee was formed to investigate shareholder concerns over director's remuneration. The report focused on
providing a means of establishing a balance between salary and performance in order to restore shareholder
confidence.

Components of directors' remuneration package

Basic salary
As with most jobs all directors are promised a specific annual salary. This is  usually determined
through benchmarking peer group salaries. Peer groups should  be industry specific and should
reference equivalent sized ventures.

The amount of the basic salary provides an indication of the performance expected from the
director, with salaries in the top quartile of payments indicating higher  levels of expected
performance.

Performance related pay (PRP)

Performance related elements of remuneration are defined as those elements of remuneration
dependent on the achievement of some form of performance measurement criteria. Good
corporate governance principles state that the performance related element should form a
significant part of the total remuneration package. 

The PRP elements of remuneration should be attainable in order to provide motivation since

unattainable targets are generally demotivating.
Also, linking PRP to share price is generally thought to be inappropriate as we cannot be
expected to control market conditions; so a general decline in market conditions is not caused by
directors’ actions and so we should not be penalized for this. Similarly, we are not responsible
for favorable market conditions and should not be rewarded for these.

i. Bonus payments
The purpose of a bonus is to adjust pay on the basis of performance. To award a bonus regardless
of any particular effort is to make the term meaningless as there is no set level of performance
necessary to actually obtain that bonus.

A bonus paid to a director at the end of the accounting year may be based on any number of
accounting measures including gross profit, net profit, earnings per share and total shareholder
value. Most corporate governance systems recommend that the bonus is linked to shareholder
value in some way to show that the shareholders' and directors' interests are the same.
ii. Shares and share options
Share options are contracts that allow the executive to buy shares at a fixed price or exercise
price. Directors make a profit if the share price of the company increases – the option is
exercised to purchase at a lower price and reselling the shares provides the profit.

Share options are good because they attempt to link company performance to director
performance in the longer term (although market factors distort this as mentioned above).

Pension contributions
These are a common part of any remuneration package. Their level is usually set in relation to
the market conditions (i.e. amounts paid to peer groups) and taking into account the age of the
director in question. It is possible that a proportion of these pensions contributions could be
performance related, providing a further incentive element to the overall package.

Benefits in kind
The provision of ‘perks’ such as a company car and health insurance is a common part of any
senior level remuneration package.

These will serve to attract directors into a role, and maybe retain them in it, but rarely have a
motivational impact. As long as they are not viewed to be excessive for the position they are
widely accepted.

Factors affecting the remuneration policy:

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.
Business size
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 capitalization 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?
Sector
Both business sector and the position of a business within it are significant.
Internationalization, 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?
Cash flow 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 organization 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.

Remuneration committees
The role of the remuneration committee is to have an appropriate reward policy that attracts,
retains and motivates directors to achieve the long-term interests of shareholders.

This definition creates a good balance between the opposing viewpoints of stakeholders.

Objectives of the committee

The committee is, and is seen to be, independent with access to its own external advice or
consultants.

 It has a clear policy on remuneration that is well understood and has the support of
shareholders.
 Performance packages produced are aligned with long-term shareholder interests and
have challenging targets.
 Reporting is clear, concise and gives the reader of the annual report a bird's-eye view of
policy payments and the rationale behind them.

The whole area of executive pay is one where trust must be created or restored through good
governance and this is exercised through the use of a remuneration committee.

Responsibilities of the remuneration committee

 Determine and regularly review the framework, broad policy and specific terms for the
remuneration and terms and conditions of employment of the chairman of the board and
of executive directors (including design of targets and any bonus scheme payments).
 Recommend and monitor the level and structure of the remuneration of senior managers.
 Establish pension provision policy for all board members.
 Set detailed remuneration for all executive directors and the chairman, including pension
rights and any compensation payments.
 Ensure that the executive directors and key management are fairly rewarded for their
individual contribution to the overall performance of the company.
 Demonstrate to shareholders that the remuneration of the executive directors and key
management is set by individuals with no personal interest in the outcome of the
decisions of the committee.
 Agree any compensation for loss of office of any executive director.
 Ensure that provisions regarding disclosure of remuneration, including pensions, as set
out in the Directors' Remuneration Report Regulations 2002 and the Code, are fulfilled.

From Book: Christine A. Mallin ,pg-204 & 205

Evaluating executives’ performance

Performance evaluations can take different forms, including formal, self- and peer-assessments.
How should board directors evaluate themselves? Regular evaluations of the board and
individual directors (especially CEOs and chief financial officers) are important, as most
investors review the quality of a directorate before committing funds.  Research also reveals that
effective performance evaluations can enhance a board’s overall functioning and the company’s
subsequent financial performance. 

Companies can report on the following aspects of executives’ performance evaluations: criteria
and time frames used, the frequency of evaluations, measurement tools used and the
persons/committees conducting these reviews. In most instances, executive performance is
evaluated against financial metrics such as return on assets (ROA), return on equity (ROE),
earnings per share (EPS), total share return (TSR), economic value added (EVA) and market
value added (MVA).

Despite being widely used, all these criteria have shortcomings. For example, a company’s EPS
should be viewed with caution as executives can manipulate reported profits.

In addition to these financial benchmarks, individual directors can be evaluated on their

knowledge of the company, their effective fulfillment of board tasks and their preparation,
attendance and participation during meetings. Evaluating boards of directors: What constitutes a
good corporate board?  When evaluating the board in its entirety, attention can be given to
meeting frequency.

A new category of performance benchmarks has emerged in recent years centring on

environmental, social and governance (ESG) considerations. ESG performance can be assessed
by, inter alia, examining risk audits and the number of fines and complaints received from
employees, customers and/or suppliers in a particular year .How does your board rate? This
category of performance criteria is expected to become more important in future as investors are
increasingly incorporating ESG considerations into their investment analyses and ownership
practices. 

Disclosure of Directors’ Remuneration:

From Book: Page-210