Remuneration Committee:

Remuneration as a corporate governance issue:

The remuneration of executive directors and senior managers is an important issue in corporate governance.It is at the heart of the conflict of interest between management and shareholders.

 

• It might be argued that executive directors and senior managers as full time employees of their company and primarily concerned about their personal remuneration.They will put concern for their personal remuneration ahead of concern for the wealth of the company's shareholders.

• Directors might attempt to increase their remuneration,without necessarily doing anything to justify the increase.

• Higher reward for managers,without any improvements in the company's performance mean lower profits for the company.

 

The issues involved in using incentives to reduce the conflict of interest and link the remuneration of directors to performance targets that are in the best interests of shareholders.

 

1.Origins of the controversy about directors remuneration:

The remuneration of executive directors is seen as a major corporate governance problem in some countries but not in others.The controversy began in the UK during the 1990's when the government privatised state-owened businesses and a member of utility companies were created in energy production,and electricity,water and gas supply.

 

The senior directors appointed to the new companies were the same individuals who had managed the business when they were state-owned.For doing much the same job as before,these individuals were given a very large increase in remuneration.They were criticised by the press as fat cats who were being paid far more than they were worth.Director's remuneration became a cause of anger in the press some years later when several high profile directors of major companies were dismissed or threatened with dismissal.Because of the terms of their employment contract,these directors were entitled on dismissal to very termination payments.These termination payments were discribed in the press as rewards for failure.

 

Criticisms of excessive directors remuneration have also been expressed by institutional investors who consider that the remuneration of directors should be linkedmuch more closely to company performance.There has been an increasing willingness by institutional shareholders to express their displeasure with remuneration for directors by voting against the board at general meetings of the company.In the UK,shareholders are able to use their votes by:

• Voting against the re-election of directors or

• Voting against the directors remuneration report;quoted companies in the UK are required to include a directors remuneration report in their annual report and accounts and shareholders are able to vote on the report,including their approval or disapproval.

 

Institutional investors have been concerned about the apparent lack of concern about directors remuneration.There have been some reported cases where shareholder action appears to have had some effect.

 

Example:

At an AGM of the media group United Business Media in 2005,the shareholders voted against the directors remuneration report .76% of shareholders voted against the director's remuneration  report at the AGM and another 11% abstained.This was a remarkable majority.

The shareholders were objecting to the ex-gratia payment of a $250,000 bonus to Lord Hollick,the departing chief executive.There was some uncertainity about whether the payment was for helping to ensure a successful handover to the incoming chief executive or for the role Lord Hollick had played in the sale NOP world a polling subsidiary.Shareholders felt that whatever the payment was for it was not justified.

Following the vote,Lord Hollick agreed to waive the bonus,UBM announced that it would not make similar ex gratia payments to directorss in the future.

 

2.Need for a remuneration committee:

The need for a remuneration committee was first recommended in the UK by the Greenbury Committee in 1995,which published a report into directors remuneration.The Greenbury report reached the following conclusions.

• Putting together a remuneration package for senior executives is a key issue in corporate governance.

• Remuneration for executive directors and other senior executives should therefore be decided by a remuneration committee of the board.

• The system for renegotiating and agreeing a remuneration package is open to abuse if executive directors can decide or influence their own remuneration arrangements.

 

The UK corporated governance cod includes the following principles about remuneratiion.

• No directors should be involved in deciding his or her own remuneration.

• There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors.

• Levels of remuneration should be sufficient to attract,retain and motivate directoors of the quality required to run the company successfully but a company should not pay more than its necessary for this purpose.

 

The Uk code therefore states that a company shold establish a remuneration committee.The committee should:

• be given delegated responsibility by the board to set the remuneration levels for all executive directos and the chairman,and

• recommend and monitor the level and structure of remuneration for senior management.(the board should decide the definition of senior managemnt but it will normally include the first layer of management below board level.)

 

3.Main duties of a remuneration committee:

The duties of a remuneration committee should be decided by the board of directors.However,the Higgs Guidance suggested that the following duties should be included:

• The committee should agree with the main board a policy for the remuneration of the chairman,CEO,other executive directors and anyother designated senior management.

• Where there is a performance-related pay scheme,the committee should decide the targets for performance.

• The committee should approve the designof any new share incentive plan.

• The committee should decide the pension arrangements for each executive director.

• Within the framework of the agreed remuneration policy,the committee should negotiate and agree the remuneration of each individual executive director.

 

4.Composition of the remuneration committee:

As with composition of the audit committee,views about the composition of the remuneration committee vary between countries.However,the general view is accepted that individuals should not be allowed to decide or influence their own remuneration.

• In the UK,the Combined Code States that in large companies,the remuneration committee should consist of at least 3 members,and all members should be independent NED.(In smaller listed companies,the remuneration committee should consist of at least two independent NEDs)

• The singapore Code of Corporate Governance doesnot specify the size of the remuneration committee.However,the committee should consist entirely of NED,the majority of whom should be independent.This is to minimize the risk of any potential conflict of interest.

5.Continuing problems with the remuneration of executive directors:

In the UK since remuneration became a significant issue for corporate governance,the remuneration of executive directors in public companies has risen at a much faster rate than pay rises generally for the working population.Remuneration committees have been criticised for making wrong judgements or overlooking aspects of remunerations and as a result remuneration has been higher then it should be.

The main reason for the problem appears to be benchmarking.This is a method of deciding the level of remuneration by making comparisons with remuneration levels in other public companies.