16. Remuneration of directors and senior executives

Question 1

All UK companies are required under the CA2006 to make certain disclosures regarding directors’ remuneration in their annual report and accounts. Which type of company is required to publish more detailed information in a separate directors’ remuneration report?

Answer 1

Quoted company

Question 2

What are the components of remuneration?

Answer 2

• Basic salary, pension, bonuses, long-term incentives (e.g. share options or awards) and other benefits and perks

Question 3

Remuneration can be divided into two elements: Fixed Pay and Variable Pay. Variable Pay can be split into what?

Answer 3

• Short-term performance-based incentives – cash bonuses or share grants – via EPS, PBIT, TSR, ROCE, etc
• Long-term incentives: share options – conditional based on certain performance targets – at an exercise price (typically market price when option issued)
• Long-term incentives: share grants – existing shares in company if they are still in job after a specified period of time, typically 3 years

Question 4

What is the risk of benchmarking?

Answer 4

FRC Guidance warns against the danger of solely benchmarking – risk to encourage an upward ratcheting effect on executive pay

Question 5

What are the drawbacks of share option schemes?

Answer 5

• Share options reward holders for increases in the share price – option holders do not benefit from dividend payments, therefore, might prefer keeping dividends low
• Bull run – share prices tend to rise regardless of the underlying strength of a company – therefore, profits from options may significantly outweigh performance
• Bear run – share prices decline – share options become worthless
• If market price falls below the exercise price for share options then those options lose their value – i.e. options being ‘under water’ or ‘out-of-the-money’ – RemCom may seek to re-price the options – institutional investors dislike this as it protects directors against the downside of a falling share price, which shareholders cannot avoid
• Executive directors may prefer long-term incentive scheme involving the grant of shares, since the shares will always have some value once they have vested

Question 6

According to Principle P, how should remuneration policies and practices be designed?

Answer 6

Principle P - Remuneration policies and practices should be designed to support strategy and promote long-term sustainable success.

Question 7

According to Principle R, what should directors exercise when authorising remuneration outcomes?

Answer 7

Independent judgement and discretion

Question 8

According to the Code, who should have delegated responsibility for determining the remuneration policy?

Answer 8

Rem Comm should have delegated responsibility for determining the remuneration policy. It should review workforce remuneration and related policies and the alignment of incentives and rewards with culture

Question 9

What does the Code say about director pensions?

Answer 9

Provision 38 - Only basic salary should be pensionable. The pension contribution rates for EDs should be aligned with the workforce.

Question 10

What does Provision 35 say about remuneration consultants?

Answer 10

Where a rem consultant is appointed, this should be the responsibility of the rem comm. The consultant should be identified in the AR alongside a statement about any other connection it has with the company or individual directors. Independent judgement should be exercised.

Question 11

How should remuneration of NEDs be determined?

Answer 11

Remuneration of NEDs should be determined in accordance with AoA or by board.

Levels of remuneration for the chair and NEDs should reflect the time commitment and responsibilities of the role.

Remuneration of NEDs should not include share options or other performance-related elements

Question 12

According to the code, what should remuneration schemes promote?

Answer 12

Provision 36 - Remuneration schemes should promote long-term shareholdings by executive directors that support alignment with long-term shareholder interests. Share awards should be released on a phased basis and subject to a holding period of 5 years or more. Rem Com should develop a formal policy for post-employment shareholding.

Question 13

According to the code, when determining the rem policy, the rem comm should address what? SCRAPP

Answer 13

1. Clarity – rem arrangements should be transparent and promote effective engagement with shareholders and the workforce;
2. Simplicity;
3. Risk – identified and mitigated;
4. Predictability – range of rewards or discretions - identified and explained at time of approving the policy;
5. Proportionality – link between awards and long-term performance should be clear – no reward for poor performance;
6. Alignment to culture – incentive schemes should drive behaviours consistent with company purpose, values and strategy

Question 14

What is the composition of a RemCom?

Answer 14

Provision 32 - Establish a rem comm of independent NEDs, with a minimum membership of 3 (2 in smaller companies)

Question 15

What are the duties of the RemCom?

Answer 15

Provision 33 – 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

FRC Guidance on Board Effectiveness – committee’s terms of reference should be made available on the company’s website

Question 16

What should a remuneration committee report include?

Answer 16

The annual remuneration report of a quoted company is required to disclose: details regarding membership of RemCom and a statement by chair on major decisions

Question 17

What should a directors’ remuneration report include?

Answer 17

s.420 of Companies Act 2006 – quoted companies (does not include AIM or NEX) are required to make detailed disclosures in a directors’ remuneration report and include
• The directors’ rem policy for approval at an AGM – approved every 3 years
• An annual remuneration report giving details of rem payments made to directors in the financial year

Question 18

A directors’ remuneration policy should be part of a directors’ remuneration report. What should be included in a directors’ remuneration policy?

Answer 18

• A table describing each component of the remuneration package offered to directors – single total figure table
• A statement of the principles which would be applied by the company
• A description of any provisions contained iin any directors’ service contract or letters of appointment which could have an impact on remuneration
• A bar chart which indicates the maximum and minimum amount payable to each director
• The company’s policy on notice periods under directors’ service contracts and the principles on which exit payments will be made
• A statement on how pay and employment conditions of employees are taken into account when setting the directors’ rem policy
• A statement on whether, and if so, how shareholders’ views expressed were taken into account

Question 19

CA2006 specifies that directors’ service contracts should not exceed how many years?

Answer 19

2 years - anything more requires shareholder approval

Question 20

What are malus and clawback provisions?

Answer 20

Malus – forfeit all or part of a bonus or long-term incentive award before it has been vested and paid

Clawback – provisions allow the company to recover sums already paid