Remuneration Package Structure:

Finding a balance between the different components of remuneration:

When a remuneration committee design a remuneration package for a director or senior manager it should consider:

• each seperate element in the package, and also

• all the elements in the package as a whole.

There are two issues to consider:the total size of the package and how it should be divided into its different components between short-term and long-term incentives between cash and equity and between current pay and pension rights.

 

Basic Salary:

The purpose of a basic salary is to give the director a guaranted  minimum amount of pay.If a director doesnot receive a basic salary,he will depend entirely on incentive payments.It could be argued that this would not be fair on the director,and would put him on her under stress.The size of basic salaries varies between companies and depends to some extent on the salaries paid to similar directors in comparable companies.However,salaries are also dependent on the extent to which directors and senior executives have an opportunity to boost their earnings through incentive scheme.A lower basic ssalary might be acceptable to a director who expects to receive large cash bonuses or equity awards.

 

Short-Term Incentives:Bonus:

Many companies have an incentive scheme for its senior executives that offers directors and other senior managers in the scheme an annual cah bonus for meeting or exceeding target performance levels.The bonus scheme may be on a sliding scale,with a bonus for meeting target and higher bonuses for exceeding targets by a certain amount.It is widely believed that the nature and potential size of annual bonuses an drive the behaviour of  senior executives.Executives will possibly be much more concerned about short-term targets and annual cash bonuses than about longer-term share incentives and bonuses,

 

There may be a cap on the maximum bonus that an individual may earn.For example, an incentive scheme may provide for a bonus equal to 25% of basic salary for meeting performance targets,with a maximum bonus of 50% of salary for exceeding targets.The bonus payments will be linked to one or more key performance indicators,possibly using a balanced score card approach.The targets may include:

• Performance indicators for the business as a whole(such as a target for earnings per share) and/or

• Personal targets for the individual executive.These might be financial targets,but might also be non-financial targets.

 

For example a sale director might receive a cash bonus of 15% of his basic ssalary if the company achieves its target profit for the year,and an additional 15% cash bonus if annual sale increase by at least 5% above the previous year.

 

Long-Term Incentive: Share Plans:

Long-Term incentive schemes usually take the form of awards of either:

• share options or

• fully paid shares in the company.

 

A company might havr several different share schemes,and individuals may participate in several or all of them.For example there may be a sharescheme or share option scheme for all employees and a seperate(additional) equity reward scheme for top executives.

 

• Share Options:

        A share option gives its holder the right at a future date,to buy shares in the company at a fixed price.For example a director might be given 20000 share options giving him the right to buy 20000 new shares in the company at a fixed exercise price of say $6.40 on or after a specified date in the future.If the company's share price increases,the director will be able to exercise the share options and buynew shares in the compny at a price below their current market price.If he wishes to do so,he can sell his new shares,and make an immediate profit.A company will appoint a committee to decide how many share options should be granted to each individual.In the case of share option schemes for senior executives,this might be a responsibility of the remuneration committee.

• In the UK,the earliest time that share options can be exercised is three years after they have been awarded.The option holder will make a profit if the share price rises above the exercise price during that time.The individual therefore has as incentive to want the share price to rise over the period.This is why share options are a long-term incentive.

• The exercise price for the share options should not be lower than the market price of the shares at the time the share options were awarded.For example,if the share price is $6.00,a company should not issue share options with an exercise price of say $5.50.(In the US several companies were accused in 2006 of back-dating share options for executives and awarding options at an exercise price equal to the market price at an earlier date,when the share price was lower).

 

• Under-Water Share Options:

A problem with share options as a long-term incentive for directors is that the share price can go down as well as up.If the share price falls below the exercise price for a directors share options,the share options are said to be 'out-of-the-money' or under water.Unless there is a reasonable chance that the share price will recover strongly the share options will there for e have no value.If they have no value,or very little value they cannot provide an incentive to the option holder.

 

Companies faced with this problem in the past have tried to maintain the incentive for a director,after the share price has fallen by:

• cancelling the existing share options and

• awarding new share options to the executive at a lower exercise price.